Fifth National Bank just issued some new preferred stock. The issue will pay an annual dividend of $15 in perpetuity, beginning 20 years from now. If the market requires a return of 4.5 percent on this investment, how much does a share of preferred stock cost today?
333.33
To calculate the cost of a share of preferred stock today, we need to determine the Present Value (PV) of the future dividend payments. In this case, the perpetual dividend payment begins 20 years from now.
The formula to calculate the present value of a perpetuity is:
PV = D / r
Where:
PV = Present Value
D = Dividend payment
r = Required return (or interest rate)
In this case, the annual dividend payment is $15, and the market requires a return of 4.5 percent (or 0.045 in decimal form).
Let's plug in the values into the formula:
PV = $15 / 0.045
PV = $333.33
Therefore, a share of preferred stock costs $333.33 today.