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18 June, 09:19

Smiling Elephant, Inc., has an issue of preferred stock outstanding that pays a $4.70 dividend every year, in perpetuity. If this issue currently sells for $79.95 per share, what is the required return

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  1. 18 June, 09:44
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    The required rate of return is 5.88%

    Explanation:

    A constant cash flow with indefinite period of time is called perpetuity. In this question a perpetual payment of dividend is being made. so the price of the share is calculated by the formula of perpetuity.

    Rate of return can be calculated from the perpetuity formula

    Present value of perpetuity = Cash flows / Required rate of return

    Present value of perpetuity = Cash flows / Required rate of return

    $79.95 = $4.70 / Required rate of return

    Required rate of return = $4.70 / $79.95 = 0.0588 = 5.88%
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