Valuing preferred stock Companies that have preferred stockholders promise to pa

Question

Valuing preferred stock Companies that have preferred stockholders promise to pay a stated dividend for an infinite period. Preferred stock is treated like a perpetuity if the payments last forever. Preferred stocks are considered to be a hybrid of a stock and a bond. Companies can suspend the dividend paid to preferred stockholders without throwing the company into bankruptcy. As with bonds, preferred stockholders receive a fixed dividend before earnings are paid out to common stockholders and, as with common stock, preferred stockholders can benefit from potential appreciation in the value of stock. Unicode Inc. pays an annual dividend rate of 9.40 percentage on its preferred stock that currently returns 12.60 percentage and has a par value of dollar 100.00. What is the value of Uninode Inc.'s stock? dollar 100.00 dollar 111.91 dollar 89.52 dollar 74.60 Suppose, due to high inflation, interest rates rise and pull the preferred stock's yield to 16.38 percentage. The value of the preferred stock will decrease

Explanation / Answer

Part A)

The value of Unicode's Stock can be calculated with the use of following formula:

Return on Stock = Annual Dividend/Current Stock Price *100

Rearranging the formula, we get,

Current Stock Price = Annual Dividend/Return on Stock where Annual Dividend = Par Value*Dividend Rate

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Using the information provided in the question, we get,

Annual Dividend = 9.40%*100 = $9.40

Current Stock Price (Value of Unicode's Stock) = 9.40/12.60% = $74.60 (which is Option D)

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Part B)

With an increase in the yield on the preferred stock, the revised stock price would be $57.99 or $58 (9.40/16.38%). Therefore, the value of preferred stock will decrease. It is so because there is an inverse relationship between the yield of the preferred stock and its price.

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