Thursday, 31 July 2014

Rabie, Inc., has an issue of preferred stock outstanding that pays a $5.70 dividend every year, in perpetuity.

Rabie, Inc., has an issue of preferred stock outstanding that pays a $5.70 dividend every year, in perpetuity.

Required:
If this issue currently sells for $80.45 per share, what is the required return? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

  Required return %  




Explanation:
The price of a share of preferred stock is the dividend divided by the required return. This is the same equation as the constant growth model, with a dividend growth rate of zero percent. Remember, most preferred stock pays a fixed dividend, so the growth rate is zero. This is a special case of the dividend growth model where the growth rate is zero, or the level perpetuity equation. Using this equation, we find the price per share of the preferred stock is:
 
R = D / P0
R = $5.70 / $80.45
R = 0.0709, or 7.09%