Help answer this question please LOII-5, LOI1-7 CASE 11.1 Factors Affecting the
ID: 2571356 • Letter: H
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Help answer this question please
LOII-5, LOI1-7 CASE 11.1 Factors Affecting the Market Prices of Preferred and Common Stocks SciFi Labs is a publicly owned company with several issues of capital stock outstanding. Over the past decade, the company has consistently earned modest profits and has increased its common stock dividend annually by 5 or 10 cents per share. Recently the company has had several impor- tant research successes and has introduced several new products that you believe will motivate future sales and profits to increase dramatically. You also expect a gradual increase in long-term interest rates from their present level of about 8 percent to, perhaps, 9 percent or 10 percent Instructions On the basis of these forecasts, explain whether you would expect to see the market prices of the following issues of SciFi capital stock increase or decrease. Explain your reasoning in each answer. a. 10 percent, $100 par value preferred stock (currently selling at $80 per share). b. S5 par value common stock (currently paying an annual dividend of $2.50 and selling at S40 per share) c. 7 percent, $100 par value convertible preferred stock (currently selling at $95 per share)Explanation / Answer
a. 10% $100 par value preferred stock is currently trading at $80, divident yield for this is dividend/Market price per share =100*10%/80=12.5% but as the interest rates are still lower than this, it can be expected that these prices may go up.
b. $5 par value common stock current dividend =2.50, dividend yield =2.5/40 *100
=6.25%.
The prices may fall down as the dividend yield is less than the interest rates.
But as the profits are also going to raise drastically and also depending on the dividend payout ratio as a result of increasing profits, the price of the common share would react.
If the dividend pay out ratio has increased and if the company is paying good dividends and if it is less than the interest rates that a common investor would get, then the prices of the common shares would rise, else the market price of the common shares would drop.
c. 7% convertible preferred stock current selling price is $95. i.e, dividend yield =$7/95 =7.37%. The prices of the convertible preference shares would drop if the price of the common shares does not raise as expected and also as the interest rates are going to raise, and is definitely more than the dividend yield on the convertible preference shares. If the price of the common stock raises, then there is a chance for the price of the convertible preference shares going up nullying the rise in the interest rate effect.
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