FIN500 Mod04 P2 Preferred Stock Valuation

Welcome to a short video showing the valuation of a non-growth stock or preferred stock. Now if all the profits are paid to the stockholders, and not retained, it's impossible for a company to grow. Therefore, growth is not considered into this calculation. Generally this does not occur and we usually reserve this formula for the evaluation of preferred stock. Now the par value represents the claim of the preferred stock against the value of the firm. This is the stock price. Now with bonds it was the initial $1,000 dollar issue price or the $1,000 dollar maturity value which is also referred as par or face value. Now preferred stocks are a hybrid in that they are similar to stocks since they represent ownership, but the payment is fixed like a bond. A company is not locked into paying that year like they would be with a bond, but eventually they must pay. Preferred dividends are fixed and provide cumulative dividends which means that past preferred stock dividends not paid, will be paid before common stock dividends. Now since the preferred are generally fixed, preferred stock can be valued as a constant growth stock with a dividend rate equal to 0. Thus, the price of a share of preferred stock can be determined using this following equation, which states that the par value of the preferred equals the dividend of the preferred divided by r, or the required rate of return on this particular asset. So find the price of a share of preferred stock given that the par value is $100 per share, and the preferred dividend rate is 8% and the required rate of return is 10%. Using the equation we find that the stock, preferred stock price is $80 dollars. Now what does this mean? If the required rate of return, based on the capital asset pricing model, is 10% and the PAR value is $80 dollars, an investor would require 10% divided by the $80 dollars or a yearly dividend return of $8 dollars, or $2 per quarter. The $8 dollars represents a 10% return on the initial $80 dollar stock price.