Preferred stock valuation TXS Manufacturing has an outstanding preferred stock i
ID: 2771938 • Letter: P
Question
Preferred stock valuation TXS Manufacturing has an outstanding preferred stock issue with a par value of S67 per share. The preferred shares pay dividends annually at a rate of 12%. What is the annual dividend on TXS preferred stock? If investors require a return of 6% on this stock and the next dividend is payable one year from now, what is the price of TXS preferred stock? Suppose that TXS has not paid dividends on its preferred shares in the last two years and is not expected to pay its current dividend, but investors believe that it will start paying dividends again in one year. What is the value of TXS preferred stock if it is cumulative and if investors require a(n) 6% rate of return?Explanation / Answer
Answer for question no.a:
Par value =$67.
Rate of preference dividends =12%.
So, annual dividend = par value of preferred stock * rate of dividend
=$67 *12%.
=$8.04
Answer for question no.b:
Required return =6% = Cost of preference shares.
Cost of preference shares Kp = D1/P0.
Here P0 = Current preference share price.
D1 is the expected preference dividend next year. = $8.04. as calculated in question no.a
P0 =D1/Kp
=$8.04/6%
=$134.
Answer for question no.c:
Dividends are not paid for three years including current year. As the preference shares are cumulative in nature and as already given in the question that next year dividends are paid, arrears of dividends received =$8.04 *3 =$24.12--------(1)
Value of preference shares after 1 year =dividend/required rate of return
=$8.04/6% =$134.-------(2)
Therefore the value of preference shares at the end of next year =(1) +(2) = $24.12+$134
=$158.12