Preferred Stock
by MaestriPreferred stock is a hybrid—it is similar to bonds in some respects and to common stock in others. The hybrid nature of preferred stock becomes apparent when we try to classify it in relation to bonds and common stock. Like bonds, preferred stock has a par value and a fixed amount of dividends that must be paid before dividends can be paid on the common stock. However, if the preferred dividend is not earned, the directors can omit (or “pass”) it without throwing the company into bankruptcy. So, although preferred stock has a fixed payment like bonds, a failure to make this payment will not lead to bankruptcy.
Some preferred stocks have a stated maturity date, say, 50 years. If MicroDrive’s preferred matured in 50 years, paid a $10 annual dividend, and had a required return of 8 percent, then we could find its price as follows: Enter N 50, I 8, PMT 10, and FV 100. Then press PV to find the price, Vp $124.47. If rp I 10%,
change I 8 to I 10, and find P Vp PV $100. If you know the price of a share of preferred stock, you can solve for I to find the expected rate of return, ˆrp.
Taken From : Five-Minute MBA – Corporate Finance
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