In a research report, a securities analyst with Smith, Kleen & Beetchnutty claims that the newly issued perpetual preferred stock of Ludicrous Telecom should be purchased because its current market price does not reflect its "intrinsic value." The analyst cites a higher valuation as evidenced by the results produced by the perpetuity valuation model. Assume the following information:
Market price of Ludicrous Telecom preferred stock: $20.75
Quarterly preferred dividend: $0.80
Expected return on the market: 14.75% per year
Risk-free rate of return: 5.00% per year
Given this information, are the claims of the analyst justified? If not, at what price is the preferred stock of Ludicrous Telecom fairly valued?
Click on the arrows to vote for the correct answer
A. B. C. D. E. F.C
Assuming that the quarterly dividend is to remain unchanged forever allows us to use the standard perpetuity model, which is illustrated as follows:
Value of preferred stock = {Annual dividend / required rate of return}
However, in this example, the required rate of return on preferred stock is not provided, and thus the answer cannot be calculated.