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Fifth National Bank just issued some new preferred stock. The issue will pay an annual dividend of $16 in perpetuity, beginning 5 years from now. If the market requires a return of 3 percent on this investment, how much does a share of preferred stock cost today

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Answer:

The answer is $473.82

Explanation:

P5 = D1/r

P5 is the price in the 5th year

D1 is the future dividend

r is the required rate of return

16/0.03

$533.33.

The price of preferred stock is the present value(PV) of the future price(FV)

PV=FV(1+r)^n

where r is the rate of return

and n is the number of years which will be 4

$533.33/(1+0.03)^4

$533.33/1.03^4

$533.33/1.1256

$473.82

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