•18. World Tobacco has issued preferred stock ($10 par value) that pays an annua

Question

•18. World Tobacco has issued preferred stock ($10 par value) that pays an annual dividend of $0.84. The preferred stock matures in 5 years. At that time, holders of the stock will receive, at their option, either $10 or one share of common stock with a value up to $14. If the common stock is trading at a price above $14, the preferred stockholders will receive a fractional share of common stock worth $14. The current common stock price is $8.875. The common stock pays a 10 cent per share dividend. This dividend is expected to grow at a 10 percent rate per year for the next 5years.Ifthemarketrequiresa12percentrateofreturnonastockofthisrisk and maturity, what is the maximum value for which this share can be expected to trade?

Explanation / Answer

Here we can Dividend discount model to calculate value of share.

D0 = $8.875 @ 10% = $0.8875, g = 10%, r = 12%, n = 5

P0 = D1 / r - g = D0 ( 1 + g )n / r - g = ($0.8875)(1+0.10)5 / 0.12 - 0.10 = $80.53

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