Smiling Elephant, Inc., has an issue of preferred stock outstanding that pays a $5.80 dividend every year, in perpetuity. If this issue currently sells for $80.50 per share, what is the required return?

Question

Jersey

Business

3 September, 18:23

Smiling Elephant, Inc., has an issue of preferred stock outstanding that pays a $5.80 dividend every year, in perpetuity. If this issue currently sells for $80.50 per share, what is the required return?

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Tripod · Answer 1

The required rate of return is 7.20%

Explanation:

The price of the preferred stock share is the dividend which is divided through the required rate of return. It is the same as the model of the constant growth, with the dividend growth rate of the 0%.

This is the special case of the model of the dividend growth where the growth rate is 0 and the level of perpetuity.

So, using the equation, compute the price per share of the preferred stock as:

Rate = Dividend (D) / Price (P0)

where

Dividend is $5.80

Price (P0) is $80.50 per share

So, putting the values above:

Rate = $5.80 / $80.50

Rate = 7.20%