Question

Earley Corporation issued perpetual preferred stock with an 8% annual dividend. The stock currently yields 7%, and its par value is $100.
a. What is the stock’s value?
b. Suppose interest rates rise and pull the preferred stock’s yield up to 9%.
c. What is its new market value?

Answer 1

Answer:

a.

Current Share Price = $87.5

c.

The new market value is $77.78

Explanation:

a.

The dividend per year on the preferred stock = 100 * 0.07 = $7

The yield on the preferred stock can be calculated as,

Yield = Preferred dividend / Current Share price

As we know the Yield and the dividend, we can calculate the current share price.

0.08 = 7 / Current Share price

Current Share Price = 7 / 0.08

Current Share Price = $87.5

c.

The dividend per share on the preferred stock remains the same at $7. The new yield is 9%. Using the yield formula we can calculate the new share price,

0.09 = 7 / New Share price

New Share Price = 7 / 0.09

New Share Price = 77.78