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Chapter 4: 24BP (page 325)

North Pole Cruise Lines issued preferred stock many years ago. It carries a fixed dividend of $6 per share. With the passage of time, yields have soared from the original 6 percent to 14 percent (yield is the same as required rate of return).

a. What was the original issue price?

b. What is the current value of this preferred stock?

c. If the yield on the Standard & Poor鈥檚 Preferred Stock Index declines, how will the price of the preferred stock be affected?

Short Answer

Expert verified
  1. The original issue price is computed as $100.
  2. The current price is $42.86.
  3. The yields on the specified preferred stock will fall.

Step by step solution

01

Computation of the original price of preferred stock

OriginalIssuePrice=DividendRateofreturn=$60.06=$100

02

Computation of the current price of preferred stock

CurrentPriceofPreferredStock=DividendNewRateofreturn=$60.14=$42.86

03

Effect on stock price

When the yield on the S&P preferred stock index falls, then the yields on the specified preferred stock will also fall because the yield on S&P preferred stock index on the given stock has a close correlation.

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Most popular questions from this chapter

Keller Construction is considering two new investments. Project E calls for the purchase of earthmoving equipment. Project H represents an investment in a hydraulic lift. Keller wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows:

Project E (\(20,000 Investment)

Year

Cash flows

1

\)5,000

2

6,000

3

7,000

4

10,000

Project H (\(20,000 Investment)

Year

Cash flows

1

\)16,000

2

5,000

3

4,000

  1. Determine the net present value of the projects based on a zero percent discount rate.

  2. Determine the net present value of the projects based on a 9 percent discount rate.

  3. The internal rate of return on Project E is 13.25 percent, and the internal rate of return on Project H is 16.30 percent. Graph a net present value profile for the two investments similar to Figure12-3. (Use a scale up to \(8,000 on the vertical axis, with \)2,000 increments. Use a scale up to 20 percent on the horizontal axis, with 5 percent increments.)

  4. If the two projects are not mutually exclusive, what would your acceptance or rejection decision be if the cost of capital (discount rate) is 8 percent? (Use the net present value profile for your decision; no actual numbers are necessary.)

  5. If the two projects are mutually exclusive (the selection of one precludes the selection of the other), what would be your decision if the cost of capital is (1) 6 percent, (2) 13 percent, (3) 18 percent? Once again, use the net present value profile for your answer.

Why is the cost of debt less than the cost of preferred stock if both securities are priced to yield 10 percent in the market? (LO11-3)

The Short-Line Railroad is considering a \(140,000 investment in either of two companies. The cash flows are as follows:

Year

Electric Co

Water works

1

\)85,000

$30,000

2

25,000

25,000

3

30,000

85,000

4-10

10,000

10,000

a. Using the payback method, what will the decision be?

b. Explain why the answer in part a can be misleading.

Stilley 91影视 bonds have four years left to maturity. Interest is paid annually, and the bonds have a \(1,000 par value and a coupon rate of 5 percent. If the price of the bond is \)841.51, what is the yield to maturity?

The Pan American Bottling Co. is considering the purchase of a new machine that would increase the speed of bottling and save money. The net cost of this machine is \(60,000. The annual cash flows have the following projections:

Year

Cashflow

1

\)23,000

2

26,000

3

29,000

4

15,000

5

8,000

a. If the cost of capital is 13 percent, what is the net present value of selecting a new machine?

b. What is the internal rate of return?

c. Should the project be accepted? Why?
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