A company pays a dividend of $6 per share to the holders of its perpetual preferred stock. The firm's bonds are currently yielding 8% per year and the firm's preferred stock are selling to yield 100 basis points below the firm's bond yield. What is the value of the preferred stock?
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A. B. C. D.C
Value = dividend/discount rate = 6/0.07= $85.71. The discount rate on the preferred stock is below that of the bonds.
To determine the value of the preferred stock, we need to calculate the present value of its future dividends. The dividends on the preferred stock are perpetual, meaning they continue indefinitely.
Given: Dividend per share = $6 Yield on bonds = 8%
We are also told that the preferred stock is selling to yield 100 basis points below the firm's bond yield. One basis point is equal to 0.01%, so 100 basis points represent 1%.
Therefore, the yield on the preferred stock can be calculated as follows: Preferred stock yield = Bond yield - 1% Preferred stock yield = 8% - 1% = 7%
Now, we can calculate the value of the preferred stock using the dividend discount model (DDM). The DDM formula is:
Value of preferred stock = Dividend per share / Preferred stock yield
Value of preferred stock = $6 / 7% = $85.71
Therefore, the value of the preferred stock is $85.71.
The correct answer is C. $85.71.