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Basic Question 2 of 16
The preferred stock of the Wordsworth Institute pays a constant annual dividend of $3.00 and sells for $20.00. You believe the stock will sell for $12.00 in one year. You must, therefore, believe that the required return on the stock will be which of the following percentage points (lower/higher) in one year?
B. It will be 8.0% higher.
C. It will be 10.0% higher.
A. It will be 8.0% lower.
B. It will be 8.0% higher.
C. It will be 10.0% higher.
User Contributed Comments 14
| User | Comment |
|---|---|
| cgeek | how to get this answer? why $20 for this year and $12 in one year |
| jamiejamie | first, solve for k at time t0 = 15% then, solve for k at time t1 = 25% you get these values using the preferred stock value (preferred stock value = dividend/k) then, you know that there is an INCREASE of 10% (25%-15%) Intuitively, you know that if you get the same dividend for a cheaper security price, then your K must have risen. |
| stefdunk | the 10% increase is not in the value of the stock, but in the rate of return you expect. You want a higher payout, so the value of the share will drop (preferred stocks and bonds: value drops if payout % rises) |
| katybo | D/K = 3/0.25 = 12 -> 0.25-0.15 = 10% |
| haarlemmer | Sine the dividend is constant, the answer is then (3/12)-(3/20)=10% |
| Done | think about it like it was a bond. since the price went down the yield should go up. That eliminates A and D, then do the math |
| faya | If 3/k=20 => k=15%; If 3/k=12 => k=25%. Therefore, to get 3/k=12, you need to increase k by 10% |
| cfahanoi | k increase => P reduce 3/12 - 3/20 = 10% |
| accounting | go for cfahanoi |
| VenkatB | jamiejamie - thanks for the explanation. |
| jansen1979 | t0: $ 20 = $ 3/x => x = 15% t1: $ 12 = $ 3/x => x = 25% Increase of 10% |
| bundy | 3/12 = 25 3/20 = 15 therefore 10% higher |
| loisliu88 | cost of preferred stock=D/r, r0= D/P0, r1= D/p1 |
| 2014 | Good work bundy |
You have a wonderful website and definitely should take some credit for your members' outstanding grades.
Colin Sampaleanu
Learning Outcome Statements
explain the rationale for using present value models to value equity and describe the dividend discount and free-cash-flow-to-equity models
calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate
identify characteristics of companies for which the constant growth or a multistage dividend discount model is appropriate
explain advantages and disadvantages of each category of valuation model
CFA® 2024 Level I Curriculum, Volume 3, Module 8.