The formula for the valuation of a share of preferred stock is P_0 = D_p/k_p. In

Question

The formula for the valuation of a share of preferred stock is P_0 = D_p/k_p. In this equation, the variable k_p represents the. Sarah is considering the purchase of 2,000 shares of the preferred stock of European Satellite Corporation. The stock carries a par value of dollar 100 per share and an annual dividend rate of 7.00 percentage. Alternative investments of comparable risk are generating yields of 4.00 percentage. Given this information, the per-share value of European Satellite's preferred stock should be: dollar 175.00 dollar 131.25 dollar 218.75 dollar 157.50 Sarah has to postpone her purchase of European Satellite's preferred shares for just over five 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 European Satellite's preferred shares to be expensive. Assume that Sarah delays her investment for another few months, and that when she is finally ready to make her 2,000-share investment in European Satellite, the market price of European Satellite's preferred stock has changed to dollar 236.25 per share. If she pays this price to acquire each share of European Satellite's preferred stock, what rate of return will Sarah earn on her investment? Remember that the shares have a par value of dollar 100 and a dividend rate of 7.00 percentage. 2.81 percentage 2.37 percentage 3.85 percentage 2.96 percentage

Explanation / Answer

The pre-share value of preferred stock = (Par value of share × Dividend rate) / Comparable risk

                                                                      = ($100 × 0.07) × 0.04

                                                                      = $175

When purchase is postponed to 5 months later, the return on comparable risk has been increased. Therefore, as a result cost of investment in preferred shares less expensive.

Rate of return on investment is calculated as follows.

Rate of return = (Par value of Preferred stock × Dividend rate) / (market price of preferred share)

                         = ($100 ×0.07) / $236.25

                         = $7 / $236.25

                          = 2.96%

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