Question

Holdup Bank has an issue of preferred stock with a $5.95 stated dividend that just sold for $96 per share. What is the bank’s cost of preferred stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

6.2%

Explanation:

The instrinsic value of the company's preferred stock can be determined as the sum of all discounted dividends. The cashflow pattern of preferred shares is similiar to perpetuity.

Preferred share price = CF/(1 + Cost of preferred stock) + CF/(1 + Cost of preferred stock)^2 + ... + CF/(1 + Cost of preferred stock)^n, or reduced form as

                                      = CF/Cost of preferred stock

Putting all the number together, we get:

96 = 5.95/Cost of preferred stock, or Cost of preferred stock = 6.2%