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http://courses.aplia.com/af/servlet/quiz?quiz action-takeQuiz&iqu; Aplia: Student QuestionChegg Study |Guided Solutio.. Previous Net2 Options X Find: Previous Next Keep the Highest: /4 Attempts: 3. The valuation of preferred stock The formula for the valuation of a share of preferred stock is Po = Dp / kp. In this equation, the variable Po represents Aa Aa the maturity value of the investment required return on the investment share's current value 0 shares of the preferred stock of Sanger Machine Company. The stock Ma carries a par value of $100 per share and an annual dividend rate of 7.00%. Alternative investments of comparable risk are generating yields of 8.00%. Given this information, the per-share value of Sanger's preferred stock should be O $87.50 O $78.7!5 O $109.38 O $65.63 Madison has to postpone her purchase of Sanger's preferred shares for just over seven months. By the time she is ready to invest, the return on alternative investments of comparable risk has increased. She should expect the cost of her investment in Sanger's preferred shares to be expensivee Assume that Madison delays her investment for another few months, and that when she is finally ready to make her 1,000-share investment in Sanger, the market price of Sanger's preferred stock has changed to $118.13 per share. If she pays this price to acquire each share of Sanger's preferred stock, what rate of return will Madison earn on her investment? Remember that the shares have a par value of $100 and a dividend rate of 7.00% 4.74% 5.93% 5.63% 771% Session Timeout 59:24 12:38 PM 4/8/2016Explanation / Answer
(a) P0 is the current value (price) of the share.
(b) Value of share = Dividend / Required return
= $100 x 7% / 0.08 = $7 / 0.08 = $87.50
(c) Higher return on alternative investments (kp) will lower the value of the share. So, cost of investment will be less expensive.
(d) $118.13 = $100 x 7% / r
r = $7 / $118.13 = 0.0593 = 5.93%
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