Question

Preferred stock valuation TXS Manufacturing has an outstanding preferred stock issue with a par value of ​$68 per share. The preferred shares pay dividends annually at a rate of 9​%. a. What is the annual dividend on TXS preferred​ stock? b. If investors require a return of 4​% on this stock and the next dividend is payable one year from​ now, what is the price of TXS preferred​ stock? c. Suppose that TXS has not paid dividends on its preferred shares in the past two​ years, 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) 4​% rate of​ return?

Answer 1

Answer:

a. Annual dividend on TXS preferred stock is $6.12 per share.

b. The price of TXS preferred​ stock is $153 per share.

c. The value of TXS preferred stock if it is cumulative and if investors require​ a(n) 4​% rate of​ return is $164.77 per share.

Explanation:

These can be calculated as follows:

a. What is the annual dividend on TXS preferred​ stock?

The formula for calculating the annual dividend on preferred stock is given as follows:

Annual dividend on preferred stock = Par value of preferred stock * annual dividend rate

Since we have the following for TXS:

Par value of preferred stock = $68 per share

Annual dividend rate = 9%

Therefore, we have:

Annual dividend on preferred stock = $68 * 9% = $6.12 per share

Therefore, annual dividend on TXS preferred stock is $6.12 per share.

b. If investors require a return of 4​% on this stock and the next dividend is payable one year from​ now, what is the price of TXS preferred​ stock?

The formula for calculating the price of preferred stock is given as follows:

Price of preferred stock = Dividend per share / Preferred stock required rate of return

Since for TXS, we have

Dividend per share = $6.12 per share

Preferred stock required rate of return = 4%, or 0.04

Therefore, we have:

Price of preferred stock = $6.12 / 0.04 = $153 per share

Therefore, the price of TXS preferred​ stock is $153 per share.

c. Suppose that TXS has not paid dividends on its preferred shares in the past two​ years, 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) 4​% rate of​ return?

Cumulative preferred stock implies that unpaid previous dividends can be carried forward as arrears to when the dividend is paid.

Since TXS has not paid dividends on its cumulative preferred shares in the past two​ years, but will start paying dividends again in one year implies that preferred stockholders will receive the dividends in arrears of one year together with the next dividend payment.

Based on this, we have

TXS preferred stock value = PV of two dividends + Preferred stock price

PV of two dividends = Present value of two dividends in arrears to paid now = M / (1 + r)^n

Where,

M = 2 * Annual dividend on TXS preferred stock  = 2 * $6.12 = $12.24

r = 4%, or 0.04

n = 1 year

Therefore, we have:

PV of two dividends = $12.24 / (1 + 0.04)^1 = $11.77

Since from part b. preferred stock price is $153 per share, we therefore have:

TXS preferred stock value = $11.77 + 153 = $164.77 per share

Therefore, the value of TXS preferred stock if it is cumulative and if investors require​ a(n) 4​% rate of​ return is $164.77 per share.