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Fifth National Bank just issued some new preferred stock. The issue will pay an annual dividend of $25 in perpetuity, beginning 14 years from now. If the market requires a return of 3.9 percent on this investment, how much does a share of preferred stock cost today

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Answer: $389.83

Explanation:

The price of a perpertuity is calculated by the formula;

= Dividend/ Required Return

= 25/3.9%

= $641.03

Present Value of Stock Price;

= [tex]\frac{641.03}{(1 + 0.039)^{13} }[/tex]

= $389.83

Note: Yearly dividends are only paid after the company has finalised its income statement for the year. So Dividends are usually paid at the beginning of the year. 13 years present value would therefore be more accurate to use than 14 years.

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