Jones Design wishes to estimate the value of its outstanding preferred stock. Th

Question

Jones Design wishes to estimate the value of its outstanding preferred stock. The preferred issue has $80 par value and pays an annual dividend of $6.40 per share. Similar-risk preferred stocks are currently earning a 9.3% annual rate of return. A) What is the market value of the outstanding preferred stock? B) If an investor purchases the preferred stock at the value calculated in part a, how much does she gain or lose per share if she sells the stock when the required return on similar-risk preferred stocks has risen to 10.5%? Explain.

Explanation / Answer

Well, the logic is similar to what you did in (a).

If similar securities now yield 10.5%, the market value of the preferred shares go even further down from the value in (a). If yield goes up, the value of the preferred shares go down.

The market value of the securities is now $6.40/10.5% = $60.95


So, your investor who bought at $68.82 will lose money if she sells at this time; her loss is $$7.87 per share, not including commissions and SEC taxes.

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