North Pole Cruise Lines issued preferred stock many years ago. It carries a fixed dividend of $6 per share. With the passage of time, yields have soared from the original 6 percent to 14 percent (yield is the same as required rate of return).
A. What was the original issue price?
B. What is the current value of this preferred stock?
C. If the yield on the Standard & Poor's Preferred Stock Index declines, how will the price of the preferred stock be affected?
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A. To find the original issue price, we need to use the formula for the price of a preferred stock:
\( \text{Price} = \frac{\text{Dividend}}{\text{Yield}} \)
Dividend = $6
Yield = 6%
\( \text{Price} = \frac{6}{0.06} = \$100 \)
Therefore, the original issue price of the preferred stock was $100.
B. To find the current value of the preferred stock, we use the same formula:
\( \text{Price} = \frac{\text{Dividend}}{\text{Yield}} \)
Dividend = $6
Yield = 14%
\( \text{Price} = \frac{6}{0.14} = \$42.86 \)
Therefore, the current value of the preferred stock is approximately $42.86.
C. If the yield on the Standard & Poor's Preferred Stock Index declines, the price of the preferred stock will increase. This is because as the yield decreases, the required rate of return decreases, making the preferred stock more attractive to investors. As a result, investors are willing to pay a higher price for the preferred stock.
A. To determine the original issue price of the preferred stock, we need to divide the fixed dividend by the yield (required rate of return). In this case, the fixed dividend is $6 per share and the yield is 6 percent.
Original Issue Price = Fixed Dividend / Yield
= $6 / 0.06
= $100
Therefore, the original issue price of the preferred stock was $100 per share.
B. To calculate the current value of the preferred stock, we need to divide the fixed dividend by the current yield (required rate of return). In this case, the fixed dividend is still $6 per share, but the yield has increased to 14 percent.
Current Value = Fixed Dividend / Current Yield
= $6 / 0.14
= $42.86 (rounded to the nearest cent)
Therefore, the current value of the preferred stock is approximately $42.86 per share.
C. The price of the preferred stock will be affected by changes in the yield on the Standard & Poor's Preferred Stock Index. As the yield on the index declines, it indicates that the market's overall required rate of return for preferred stocks has decreased.
When the yield on the index declines, the price of the preferred stock will increase. This is because investors will be willing to pay a higher price for the preferred stock to achieve the same yield as the market. As a result, the current value of the preferred stock will increase.
Conversely, if the yield on the index increases, indicating a higher required rate of return for preferred stocks in the market, the price of the preferred stock will decrease. Investors will demand a higher return, resulting in a lower price for the preferred stock.