59533341-FM11-Ch-07-Instructors-Manual-1

Preferred dividends are similar to interest payments

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Unformatted text preview: to common stock in other respects. Preferred dividends are similar to interest payments on bonds in that they are fixed in amount and generally must be paid before common stock dividends can be paid. If the preferred dividend is not earned, the directors can omit 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. Most preferred stocks entitle their owners to regular fixed dividend payments. 7-2 True. The value of a share of stock is the PV of its expected future dividends. If the two investors expect the same future dividend stream, and they agree on the stock¶s riskiness, then they should reach similar conclusions as to the stock¶s value. 7-3 A perpetual bond is similar to a no-growth stock and to a share of preferred stock in the following ways: 1. All three derive their values from a series of cash inflows--coupon payments from the perpetual bond, and dividends from both types of stock. 2. All three are assumed to have indefinite lives with no maturity value (M) for the perpetual bond and no capital gains yield for the stocks. Answers and Solutions: 7 - 3 SOLUTIONS TO END-OF-CHAPTER PROBLEMS 7-1 D0 = $1.50; g1-3 = 5%; gn = 10%; D1 through D5 = ? D1 = D0(1 + g1) = $1.50(1.05) = $1.5750. D2 = D0(1 + g1)(1 + g2) = $1.50(1.05)2 = $1.6538. D3 = D0(1 + g1)(1 + g2)(1 + g3) = $1.50(1.05)3 = $1.7364. D4 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn) = $1.50(1.05)3(1.10) = $1.9101. D5 = D0(1 + g1)(1 + g2)(1 + g3)(1 + gn)2 = $1.50(1.05)3(1.10)2 = $2.1011. Ö D1 = $0.50; g = 7%; rs = 15%; P0 = ? Ö = D1 0 = rs  g 7-3 $0.50 0.15  0.07 = $6.25. P0 = $20; D0 = $1.00; g = 10%; ¡ 7-2 1 = ?; › r s= ? Ö P1 = P0(1 + g) = $20(1.10) = $22. › rs = = 7-4 1 P0 +g= $1.10 $20 $1.00(1.10) + 0.10 $20 › + 0.10 = 15.50%. r s = 15.50%. Dps = $5.00; Vps = $60; rps = ? rps = D ps v ps = $5.00 = 8.33%. $60.00 Answers and Solutions: 7 - 4 0 1 2 | | | D1 D2 D0 = 2.00 Ö 3 | D3 ¢ 7-5 2 Step 1: Calculate the required rate of return on the stock: rs = rRF + (rM - rRF)b...
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