Which of the following is the formula for the value of preferred stock?
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A. B. C. D.B
The value of preferred stock is the stated annual dividend divided by the required rate of return on preferred stock.
The correct answer is D. the present value of an infinite stream of dividends.
Preferred stock is a type of security that represents ownership in a company, but with a fixed dividend payment rather than the variable dividend payments associated with common stock. The value of preferred stock is determined by calculating the present value of its expected future dividend payments.
Preferred stockholders receive a fixed dividend payment, which is typically expressed as a percentage of the par value of the stock. This dividend is paid out to preferred stockholders before any dividends are paid to common stockholders. The required rate of return on preferred stock represents the return that investors expect to earn on their investment.
To calculate the value of preferred stock, the formula uses the present value concept, which discounts future cash flows to their present value. The formula for the value of preferred stock is:
Value of Preferred Stock = Dividend / Required Rate of Return
The value of preferred stock is equal to the dividend payment divided by the required rate of return. This formula reflects the idea that the value of an investment is determined by the present value of its expected future cash flows. By dividing the expected dividend payment by the required rate of return, we are discounting the future dividend payments to their present value.
Option A (dividend multiplied by the required rate of return) and Option C (required rate of return divided by the dividend) are incorrect because they do not reflect the present value concept. Multiplying the dividend by the required rate of return does not take into account the time value of money or the discounting of future cash flows.
Option B (dividend divided by the required rate of return) is also incorrect because it does not consider the present value of the dividend payments. Simply dividing the dividend by the required rate of return would provide the total number of periods it would take to recover the initial investment, but it does not give the present value of the preferred stock.
Therefore, the correct answer is D. the present value of an infinite stream of dividends, which represents the value of preferred stock by discounting the expected future dividend payments to their present value using the required rate of return.