Question 1

Wernam Hogg Class A preferred shares have a par value of $100 and offer an annual dividend at 0.8% of par value.Wernham Hogg Class A Preferred shares paid their annual dividend yesterday and are currently priced at $16 to yield 5%.The central bank is threatening to tighten monetary policy.The chief economist predicts that all interest rates will rise by 2% over the coming year (the yield on the Wernham Hogg Class A Preferred shares will also rise to 7%).If you sell your Wernham Hogg Class A Preferred shares in one year after the interest rate increase (and after the next dividend),then what return will you have earned on the investment assuming that you bought at today's price?

Accepted Answer

Step 1 - Calculate the preferred stock price after the rise in interest rates. 11ea7fdb_fbed_2734_a768_334386c15c1b_TB2902_11 = 11ea7fdb_fbed_2735_a768_4db30b14ab6f_TB2902_11 11ea7fdb_fbed_2736_a768_d39062774982_TB2902_11 = 11ea7fdb_fbed_2737_a768_5317e64536b9_TB2902_11 = $11.429
Step 2 - Calculate the return after selling the stock.
Return = 11ea7fdb_fbed_2738_a768_65f65d07e770_TB2902_11 Return = 11ea7fdb_fbed_4e49_a768_4344c08fd95b_TB2902_11 = -23.6%

Question 2

The purchase and sale of securities after the original issuance occurs in the:

Accepted Answer

This type of market is called the Secondary Market.

Question 3

You just purchased preferred shares in Initech for $45.71.Initech pays annual dividends of $0.64.What is your required return on this investment?

Accepted Answer

11ea7fdb_fbeb_a074_a768_ebab1e30109b_TB2902_11 = 11ea7fdb_fbeb_a075_a768_b1444749fc5b_TB2902_11 45.71 = 11ea7fdb_fbeb_a076_a768_d9a176963bae_TB2902_11 45.71k = .64
k = 1.4%

Question 4

A share of preferred stock pays a quarterly dividend of $2.50.If the price of this preferred stock is currently $50,what is the nominal annual rate of return?

Accepted Answer

Step 1 - Annualize the quarterly dividend payment.
2.50 × 4 = $10.
Step 2 - Use the annualized dividend to calculate the nominal return.
k = 11ea7fdb_fbed_c380_a768_1997e4059888_TB2902_11 k = 11ea7fdb_fbed_c381_a768_bbef0bcc3550_TB2902_11 = 20%

Question 5

The preferred stock of Selena Corp.pays a dividend of $1.50 per share.If Selena preferred stock currently sells for $10 per share,the required rate of return is:

Accepted Answer

i = 11ea7fdb_fbee_11a8_a768_19e2c1f78648_TB2902_11 i = 11ea7fdb_fbee_38b9_a768_5bd9db93bd33_TB2902_11 = 15%

Question 6

Assume that you would like to purchase 100 shares of preferred stock that pays an annual dividend of $6 per share.However,you have limited resources now,so you cannot afford the purchase price.In fact,the best that you can do now is to invest your money in a bank account earning a simple interest rate of 6%,but where interest is compounded daily (assume 365 days).Because the preferred stock is riskier,it has a required annual rate of return of 12% (assume that this rate will remain constant over the next 5 years).For you to be able to purchase this stock at the end of 5 years,how much must you deposit in your bank account today,at t = 0?

Accepted Answer

Step 1 - Calculate the price of the preferred stock. 11ea7fdb_fbed_ea92_a768_3d5b7678cfb5_TB2902_11 = 11ea7fdb_fbed_ea93_a768_0522c2be46eb_TB2902_11 11ea7fdb_fbed_ea94_a768_6d96ba9a85db_TB2902_11 = 11ea7fdb_fbed_ea95_a768_e1d9eee6f4a4_TB2902_11 = 50.00
Step 2 - Multiply the price by the number of shares desired.100 × $50 = $5,000 is the future value of money to purchase the preferred stock.
Step 3 - Use the time value of money calculation to find the present value needed to reach your goal.
PV = 11ea7fdb_fbed_ea96_a768_fbac4be7a942_TB2902_11 PV = 11ea7fdb_fbed_ea97_a768_f7af4353772b_TB2902_11 = $3,704.18
Or, with a financial calculator:
N = 1825, I/Y = .016438356, PMT = 0, FV = -5000, cpt PV = $3,704.18

Question 7

All of the following are characteristics of common stock EXCEPT:

Accepted Answer

Dividends paid on common stock are not tax-deductible.

Question 8

Pan Am Airlines issued emergency preferred shares after its reorganization.The preferred share has a fixed dividend of $1 payable at the end of each of the next three years.At the end of the three years it matures and pays its par value.The par value is equal to the value of the common shares at that time.The common shares are currently trading for $37.08.They pay no dividends currently,but are forecast to begin paying a dividend in four years at $3.55 per share.The dividend is expected to grow at 4% in perpetuity and common shareholders expect a return of 11%.What is the fair market value for the preferred shares today if the preferred shareholders require a 9% rate of return?

Accepted Answer

Step 1 - Calculate the present value of the preferred dividends. PV = 11ea7fdb_fbec_b1fd_a768_dd4adc78d2a1_TB2902_11 = $.9174 PV = 11ea7fdb_fbec_b1fe_a768_312de34cc6b8_TB2902_11 = $.8417 PV = 11ea7fdb_fbec_d90f_a768_93bcd5bd3c7e_TB2902_11 = $.7722 Step 2 - Add these cash flows together. .9174 + .8417 + .7722 = $2.53. Step 3 - Calculate the value of the common stock in three years and discount it back to today. P₀ = 11ea7fdb_fbec_d910_a768_ad309a237b87_TB2902_11 P₀ = 11ea7fdb_fbec_d911_a768_a9c741f409f2_TB2902_11 = 50.71 PV = 11ea7fdb_fbec_d912_a768_dba4ac3e6e1a_TB2902_11 PV = 11ea7fdb_fbec_d913_a768_8f1804d23e20_TB2902_11 = $39.16 Step 4 - Add all the present values together 2.53 + 39.16 = $41.69

Question 9

Universal Export's preferred shares pay a 6.5% annual dividend on a $50-par value.The next dividend is due in one year.The required return of preferred shareholders is 9%.What is the fair price for the preferred shares?

Accepted Answer

11ea7fdb_fbeb_ee9d_a768_6585cc24a736_TB2902_11 = 11ea7fdb_fbec_15ae_a768_c3b924631ca6_TB2902_11 11ea7fdb_fbec_15af_a768_5b8ce15fa616_TB2902_11 = 11ea7fdb_fbec_15b0_a768_49b1c0d6899d_TB2902_11 = $36.11

Question 10

Versalife Inc.just paid a dividend of $1.32 on its common stock,and the next dividend will be paid one year from now.You require a return of 6%.What is the market price of this stock if there is no growth in annual dividends?

Accepted Answer

A common stock with no growth is priced the same as a preferred stock
P = 11ea7fdb_fbeb_ee9b_a768_ad46b6ac915b_TB2902_11 P = 11ea7fdb_fbeb_ee9c_a768_c52ffd907108_TB2902_11 = $22

Question 11

________ have a higher payment priority than do ________.

Accepted Answer

Preferred dividends are paid before common dividends.

Question 12

Preferred stock is valued as if it were

Accepted Answer

A preferred stock is a perpetuity.

Question 13

An 8 percent preferred stock with a market price of $110 per share and a $100 par value pays a cash dividend of ________.

Accepted Answer

.08 × 100 = $8.00

Question 14

Which of the following is not a characteristic of preferred stock?

Accepted Answer

Common stock dividends are paid only after preferred stock dividends have been paid.

Question 15

A share of preferred stock pays a dividend of $0.50 each quarter.If you are willing to pay $20.00 for this preferred stock,what is your nominal (not effective)annual rate of return?

Accepted Answer

Step 1 - Annualize the quarterly dividend payment.
.50 × 4 = $2
Step 2 - Use the annualized dividend to calculate the nominal return.
k = 11ea7fdb_fbed_9c6e_a768_bf10eae99140_TB2902_11 k = 11ea7fdb_fbed_9c6f_a768_f50a0a2eca03_TB2902_11 = 10%

Question 16

A share of perpetual preferred stock pays an annual dividend of $6 per share.If investors require a 12% rate of return,what should be the price of this preferred stock?

Accepted Answer

11ea7fdb_fbee_38ba_a768_759f0ed1c286_TB2902_11 = 11ea7fdb_fbee_38bb_a768_bf2e657d3c63_TB2902_11 11ea7fdb_fbee_38bc_a768_516976a9b03a_TB2902_11 = 11ea7fdb_fbee_38bd_a768_a1620c29f42a_TB2902_11 = 50.00

Question 17

If Genco's preferred stock pays a dividend of $5 per share and its investors require an 8% return,what should its price per share of preferred stock be?

Accepted Answer

11ea7fdb_fbeb_c787_a768_4f715f82e811_TB2902_11 = 11ea7fdb_fbeb_c788_a768_251f4cbd187f_TB2902_11 11ea7fdb_fbeb_c789_a768_2d57fba66745_TB2902_11 = 11ea7fdb_fbeb_c78a_a768_d14a195c8ce6_TB2902_11 = $62.50

Question 18

Universal Export's Preferred shares will pay their first dividend in five years.The dividend will be 6.5% on a $50-par value.Assume that the dividends will continue annually in perpetuity at that level.The required return of preferred shareholders is 9%.What is the fair price for the preferred shares?

Accepted Answer

Step 1 - Solve for the price of the stock when it begins paying a dividend. 11ea7fdb_fbec_3cc1_a768_9fa54361b6e6_TB2902_11 = 11ea7fdb_fbec_3cc2_a768_d7ada4c4e714_TB2902_11 11ea7fdb_fbec_3cc3_a768_f3c5908f6ab8_TB2902_11 = 11ea7fdb_fbec_3cc4_a768_c1c3fffa9bf5_TB2902_11 = $36.11
Step 2 - Discount that stock price back to today.
PV = 11ea7fdb_fbec_3cc5_a768_f1ed30ca539f_TB2902_11 PV = 11ea7fdb_fbec_3cc6_a768_d993968c907f_TB2902_11 = $25.58

Question 19

A firm has an issue of preferred stock outstanding that has a stated annual dividend of $4.The required return on the preferred stock has been estimated to be 16 percent.The value of the preferred stock is ________.

Accepted Answer

11ea7fdb_fbed_4e4a_a768_73546b33fea0_TB2902_11 = 11ea7fdb_fbed_755b_a768_5f11482a8d87_TB2902_11 11ea7fdb_fbed_755c_a768_7314b9163583_TB2902_11 = 11ea7fdb_fbed_755d_a768_6764ad04efc8_TB2902_11 = $25

Question 20

Wernam Hogg Class A preferred shares have a par value of $100 and offer an annual dividend at 0.8% of par value.Wernham Hogg is experiencing cash flow problems due to poor market conditions in the commercial paper business.The company has suspended dividends on the Class A preferred shares.Analysts do not expect the dividends to resume for another 3 years,at which point they are expected to resume in perpetuity.If investors require a return of 2.25%,then what is the fair price for the preferred shares today?

Accepted Answer

Step 1 - Solve for the price of the stock when it begins paying a dividend. 11ea7fdb_fbec_63d7_a768_cf5776404c78_TB2902_11 = 11ea7fdb_fbec_8ae8_a768_d145d4b71ad9_TB2902_11 11ea7fdb_fbec_8ae9_a768_bda92bc098f6_TB2902_11 = 11ea7fdb_fbec_8aea_a768_4d95f6528889_TB2902_11 = $35.56
Step 2 - Discount that stock price back to today.
PV = 11ea7fdb_fbec_8aeb_a768_f53fbc259a11_TB2902_11 PV = 11ea7fdb_fbec_8aec_a768_cb137d925a30_TB2902_11 = $34.01

Quiz 8: Stock Valuation and Market Efficiency