1.BAC is considering an issue of preferred stock. The dividends are 8.12% of the $25 par value.
a.If the current price is $26.25 per share, what is the return on the preferred stock?
b.Suppose the preferred stock will mature in 20 years. If the price is $26.25 per share, what is the return on the preferred stock? HINT: This is just like a bond, but the face value is 25. For the problem, you can assume the dividends are annual.
To calculate the return on the preferred stock, we need to determine the annual dividend payment first.
a. To find the annual dividend payment, we can multiply the dividend rate of 8.12% by the par value of $25:
Annual dividend payment = 8.12% x $25 = $2.03
Now, we can calculate the return on the preferred stock by dividing the annual dividend payment by the current price per share and multiplying by 100 to express it as a percentage:
Return on preferred stock = ($2.03 / $26.25) x 100% = 7.75%
b. To calculate the return on the preferred stock if it matures in 20 years, we need to consider the total return over the 20-year period. Since this is similar to a bond, we can use the present value formula to estimate the return.
The present value formula is:
P = C / (1 + r)^t
Where:
P is the current price per share ($26.25)
C is the annual dividend payment ($2.03)
r is the required rate of return or interest rate
t is the number of years (20 in this case)
We need to rearrange the formula to solve for r. By substituting the given values, we can solve for r:
$26.25 = $2.03 / (1 + r)^20
To determine r, we can use a financial calculator or spreadsheet software to solve for it. The result will give us the required rate of return. This rate will represent the return on the preferred stock over the 20-year period.