Debt Consolidation Loan

Finding the value of a share of preferred stock could not be easier! Preferred stock is unlike common stock in that the dividends paid to shareholders do not grow. The other important factor to consider is that shares of preferred stock typically do not have a maturity date. So putting these facts together, we have some payment (the dividend) that occurs forever. Sound familiar? This is just like what we learned in our time value of money section when we studied perpetuities.

There is a very simple formula to value preferred stock. Let's take a look at it and understand the notation:

Where:
Vps	This is the intrinsic value of a share of preferred stock. In other words, this is what the preferred stock is worth today. It is a fair price for a share of this preferred stock.
D	This is the dollar value of the dividend. Remember, you will always use a dollar value for D!
kps	This is the required rate for a share of preferred stock. This will be a percent so always put this in as decimal form (i.e. 8% = 0.08).

Now that we understand the basic formula for preferred stock valuation, lets try a sample problem. UnderstandFinance preferred stock pays a $3 annual dividend and investors require 9% for a stock of this risk level. What is the intrinsic value of this preferred stock?

This one gives us all of the puzzle pieces up front! We have $3 as our value for D and 9% as our required rate. The only trick here is to remember to put the 9% in as a decimal. Your formula should look like this:

Before moving on to a slightly harder problem, we need to have a discussion on par value of preferred stock. The par value is typically $25, $50, $75, or $100. This is extremely important! Some problems will not give you a dollar value for a dividend, but instead tell you the dividend rate. The dividend rate is simply the percent of par value that is paid out each year in the form of dividends. The following problem will show you what we're talking about here:

Magic Carpet Company's preferred stock has a par value of $50 and a dividend rate of 8%. If investors' required rate is 10%, what is a fair price for this preferred stock?

Here we need to turn that dividend rate into a dollar value. Just multiply the par value times the dividend rate to get D. Your formula should look like this:

Practice Problem 1
Wooden Pencil Accounting's preferred stock recently paid a dividend of $5.50. The par value of their preferred stock is $75. Investors require an 11.5% rate of return on this stock. What is the intrinsic value of the preferred stock?

Solution:
You should have found an intrinsic value of $47.83. In this case, we didn't even need to know the par value since the dividend was given to us in dollars.

Practice Problem 2
FinanceCorp's preferred stock has a par value of $50 and a dividend rate of 5%. Investors require an 7% rate of return on this stock. What is the intrinsic value of the preferred stock?

Solution:
Did you get an answer of $35.71? If not, make sure you are using decimal form for your required rate!

I think our work is done here. To talk about this tutorial or any other, please visit the UnderstandFinance.com forum.

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