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Although preferred stock is an equity instrument, it is easy valued. Technically it is a perpetuity. As previously explained in time value of money, to value a perpetuity, simply take the annual return in dollars and divide by the appropriate discount rate. The annual return in dollars for a share of preferred stock would be the dividend rate, which is found by taking the dividend rate and multiplying it by the par value for the preferred. The formula for valuing preferred stock could then be written as follows.
| P0 = |
D
kp |
|
|
| where: |
|
| D = |
Annual dividend in $ |
| kp = |
Investors' required rate on similar preferred |
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An example illustrates the use of the formula. A share of preferred that pays a 5.25% dividend has a par value of $100. If the investors' required rate of return is 9%, what would be the price?
| P0 = |
5.25
.09 |
= $58.33 |
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The yield on a share of preferred may be calculated by a simple manipulation of the pricing formula.
| Kp = |
D
P0 |
|
So if a 3.25%, $100 par preferred were selling for $50, the investors' required rate of return would be 6.5%.
| Kp = |
3.25
50 |
= 0.065 = 6.5% |
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