prashantsahni

If a preferred stock that pays a $11.50 dividend is trading at $88.46, what is the market’s required rate of return for this security?

A) 11.76%.

B) 13.00%.

C) 7.69%.

---

From the formula: ValuePreferred Stock = D / kp, we derive kp = D / ValuePreferred Stock = 11.50 / 88.46 = 0.1300, or 13.00%.

prashantsahni

A company has 6% preferred stock outstanding with a par value of $100. The required return on the preferred is 8%. What is the value of the preferred stock?

A) $92.59.

B) $100.00.

C) $75.00.

---

The annual dividend on the preferred is $100(.06) = $6.00. The value of the preferred is $6.00/0.08 = $75.00.

prashantsahni

What is the value of a preferred stock that is expected to pay a $5.00 annual dividend per year forever if similar risk securities are now yielding 8%?

A) $40.00.

B) $60.00.

C) $62.50.

---

$5.00/0.08 = $62.50.

prashantsahni

The preferred stock of the Delco Investments Company has a par value of $150 and a dividend of $11.50. A shareholder’s required return on this stock is 14%. What is the maximum price he would pay?

A) $150.00.

B) $54.76.

C) $82.14.

---

Value of preferred = D / kp = $11.50 / 0.14 = $82.14

prashantsahni

An analyst projects the following pro forma financial results for Magic Holdings, Inc., in the next year:

• Sales of $1,000,000
• Earnings of $200,000
• Total assets of $750,000
• Equity of $500,000
• Dividend payout ratio of 62.5%
• Shares outstanding of 50,000
• Risk free interest rate of 7.5%
• Expected market return of 13.0%
• Stock Beta at 1.8

If the analyst assumes Magic Holdings, Inc. will produce a constant rate of dividend growth, the value of the stock is closest to:

A) $19

B) $104

C) $44

---

Infinite period DDM: P0 = D1 / (ke – g)

D1	= (Earnings × Payout ratio) / average number of shares outstanding
	= ($200,000 × 0.625) / 50,000 = $2.50.
ke	=  risk free rate + [beta × (expected market return – risk free rate)]
ke	=  7.5% + [1.8 × (13.0% - 7.5%)] = 17.4%.
g	=    (retention rate × ROE)
		Retention = (1 – Payout) = 1 – 0.625 = 0.375.
		ROE  = net income/equity
				= 200,000/500,000 = 0.4
g	= 0.375 × 0.4 = 0.15.

P0 = D1 / (ke – g) = $2.50 / (0.174 - 0.15) = 104.17.

prashantsahni

A firm pays an annual dividend of $1.15. The risk-free rate (RF) is 2.5%, and the total risk premium (RP) for the stock is 7%. What is the value of the stock, if the dividend is expected to remain constant?

A) $25.00.

B) $12.10.

C) $16.03.

---

If the dividend remains constant, g = 0.
P = D1 / (k-g) = 1.15 / (0.095 - 0) = $12.10