Thurber Inc. has Issued both common and preferred stock. Thurber\'s common stock

Question

Thurber Inc. has Issued both common and preferred stock. Thurber's common stock just paid a $1.60 dividend and Its current price Is $22 per share. The common dividend is expected to grow at a constant rate of 5% per year. Thurber's preferred stock pays a perpetual $8.50 annual dividend and sells for $98.25. The preferred stock price is expected to remain constant in the foreseeable future. Use the table below to indicate the expected total return, expected dividend yield, and expected capital gains yields on Thurber's common and preferred stock. Expected total return Expected dividend yield Expected capital gains yield Common stock Preferred stock Which is riskier, Thurber's common or preferred stock? Thurber's preferred stock is riskier. Thurber's common stock is riskier. They are of equal risk.

Explanation / Answer

for common stock

let expected return = r

using dividend discount model

stock price = D1/(r-g)

22 = 1.6*1.05/(r-.05)

r = (1.6*1.05/22)+.05 = 12.64%

expected dividend yield = 1.6*1.05/22 = 7.64%

expected capital gain yield

Price of stock after 1 year = 1.6*1.05*1.05/((.1264-.05)*(1.1264)) = $20.50

capital gain yield = (20.5-22)/22 = -6.81%

for preferrerd stock

let expected return = r

98.25 = 8.5/r

r = 8.5/98.25 = 8.65%

expected dividend yield = 8.65%

expected capital gain yield = 0

b) common stock is riskier because its price is more changing and its dividend is also changing but for preferred stock every thing is constant

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