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 Subject: Finance Category: Business and Money > Finance Asked by: baseball2-ga List Price: \$5.00 Posted: 30 Jul 2005 12:49 PDT Expires: 29 Aug 2005 12:49 PDT Question ID: 549836
 ```Need to check if I am doing my calculation right. Background information is: A company has issued preferred stock witn an annual 8.00 divident that will be paid inperpetutity. The discount rate is 12 percent. Would the calucalion to state what price the preferred sell be 8/.12=\$66.66? Would the calculation to determine what the price should the stock seell in 1 year from now be 8.00 + 66.66 / 12 = 67.52 Would the expected rate of return be 8 + 67.52 - 66.66 / 66.66 = 13% What would the calculation be to determen divedent yeild and capital gain yeild? Any help would be greatful. Thanks```
 ```Baseball2 ? The general case for figuring a stock value (it also figures a bond or loan value too) is: P0 = D1 / (r-g) P0 = today's price D1 = dividends in period 1 r = required rate of return (in decimals) g = dividend growth rate You?ve simplified this greatly by saying that there?s an annual dividend and that it never changes. So, g (growth rate) = 0 and today?s price is: P0 = D1 / r As a result you?ve figured the price correctly at \$66.67. --- Essentially the \$8 paid on the preferred is the ?interest? on holding 1 share of the \$66.67 stock. In fact, securities analysts would move this preferred stock into ?debt? rather than equity when doing a discounted cash flow. The dividends won?t change a year from now ? they?ll still be \$8 and still be paid in perpetuity. This stock price will change only if the discount rate changes. So it will still be \$66.67. The dividend yield will match the discount rate ? by definition. But you can calculate it too: Yield = Dividend / Stock Price = \$8 / \$66.67 = .12 or 12% With no change in stock price, there?s no capital gain. --- A final note: if there were some constant growth in the dividend, of say 4% you?d recalculate the stock price every year and would be able to determine capital gains. But in the case of a constant perpetuity, it changes price only with a change in discount rate or if the company should default on the dividends. Best regards, Omnivorous-GA``` Request for Answer Clarification by baseball2-ga on 31 Jul 2005 15:20 PDT ```Thanks Livioflores! I am still a bit confused with the final portion of your answer. Actually, I gave you one wrong bit of information. I neglected to tell you the discount rate would rise to 12% therfore that is why I asked if 67.52 is the correct amount for the stock in one year. I am not sure that I followed your last part of your answer. However, this is how I figured the following (if you tell me if I am going in the right direction that would be grteat) Divendend yeild 67.53-66.67 / 66.67 = 1.29 Capital gain 67.52+ 66.67/ 66.67 = 2.01 Expected rate of return = 67.52 - 66.67/ 66.67 = 13%``` Request for Answer Clarification by baseball2-ga on 31 Jul 2005 18:16 PDT `Sorry I meant thank you ominivorous!` Clarification of Answer by omnivorous-ga on 31 Jul 2005 18:23 PDT ```Baseball2 -- I think that you meant that the discount rate rises to 13% (not 12%). And just to be clear: this happens at the end of year 1, correct? Note that this causes the stock to DECLINE. However, if the discount rate starts at 13% (stock price \$61.54), then the stock will rise with a new discount rate of 12% (\$66.67). As a side note: the stock drops by \$8 on the day after the dividend is paid -- then slowly rises by \$8 until the end of the dividend-year. So we do have to be careful about choosing comparable dates each year. Best regards, Omnivorous-GA```