Valuing Preferred Stock. E-Eyes.com has a new issue of preferred stock it calls

Question

Valuing Preferred Stock. E-Eyes.com has a new issue of preferred stock it calls 20/20 preferred. The stock will pay a $20 dividend per year, but the first dividend will not be paid until 20 years from today. If you require a return of 8 percent on this stock, how much should you pay today?

7.11. With a return of 8 percent on this stock, how much should you pay? Hint: Once the stock begins paying dividends, it will have the same dividends forever, a preferred stock. We value the stock at that point, using the preferred stock equation. It is important to remember that the price we find will be the price one year before the first dividend (Show work):

P0 =

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Stock Valuation. Alexander Corp. will pay a dividend of $2.72 next year. The company has stated that it will maintain a constant growth rate of 4.5 percent a year forever. If you want a return of 12 percent, how much will you pay for the stock? What if you want a return of 8 percent? What does this tell you about the relationship between the required return and the stock price?

7.12.    Value a stock with two different required returns. Use the constant growth model.

Price @ required return of 12%: (Show work):

P0 =

b. Price @ required return of 8%: (Show work):

   P0 =

    c. What does a higher required return mean to the stock?

Explanation / Answer

7.11

Po just before the stock stars paying dividend perpetually = 20/0.08 = $250

20 years before paying dividend, stock price should be at 8% return = 250/(1.08)^19 = $57.92

7.12

Using Gordon growth model to value stocks paying dividends

Price @ required return of 12% = 2.72/(0.12-0.045) = $36.26

Price @ required return of 8% = 2.72/(0.08-0.045) = $77.71

Higher return means lower stock price

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