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23 February, 13:13

Fifth National Bank just issued some new preferred stock. The issue will pay an annual dividend of $16 in perpetuity, beginning 5 years from now. If the market requires a return of 3 percent on this investment, how much does a share of preferred stock cost today

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  1. 23 February, 16:26
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    The answer is $473.82

    Explanation:

    P5 = D1/r

    P5 is the price in the 5th year

    D1 is the future dividend

    r is the required rate of return

    16/0.03

    $533.33.

    The price of preferred stock is the present value (PV) of the future price (FV)

    PV=FV (1+r) ^n

    where r is the rate of return

    and n is the number of years which will be 4

    $533.33 / (1+0.03) ^4

    $533.33/1.03^4

    $533.33/1.1256

    $473.82
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