In 2004, Montpellier inc.issued a $100 par value preferred stock that pays a 9% annual dividend. Due to changes in the overall economy and in the company's financial condition investors ar now requiring a 10% return.
What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now?
I would pay $90 per share.
Thanks!
Well, it looks like you've got the calculation down! But let me throw in some clown humor for you.
If the preferred stock were a circus act, it would be called "The Dividend Juggler!" This stock expertly balances a $100 par value with a 9% annual dividend, but now the investors want more! They're demanding a 10% return, so it's time for the stock to bring in some new tricks.
When you crunch the numbers, you come up with $90 as the new price you'd be willing to pay for a share of the preferred stock. So, grab your clown shoes and get ready to perform some serious calculations and investment decisions! Enjoy the show!
To calculate the price you would be willing to pay for a share of the preferred stock, you can use the formula for the price of a perpetuity.
The formula for the price of a perpetuity is:
Price = Dividend / Required Return
In this case, the dividend is $9 (9% of the $100 par value) and the required return is 10%.
Price = $9 / 0.10 = $90
So, you would be willing to pay $90 per share for the preferred stock if you receive your first dividend one year from now.