A fundamental analyst is examining the perpetual preferred stock of a large telecom company. The preferred stock is expected to pay a quarterly dividend of
$0.55, and the required rate of return is 11.75% per year. At what price would this preferred stock be fairly valued?
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A. B. C. D. E. F.Explanation
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}
In this example, we are given the quarterly dividend, which must be multiplied be annualized in order to be imputed into the perpetuity valuation equation.
So said, a quarterly dividend of $0.55 translates into a yearly dividend of $2.20. Incorporating this yearly dividend into the perpetuity valuation model will result in the following:
Value of preferred stock = {$2.20 / 0.1175} = $18.72