Ria's Doll Company has an outstanding preferred issue of stock with a par value of $100 and an annual dividend of 10 percent (of par). Similar risk preferred stocks are yielding an 11.5 percent annual rate of return
(a) What is the current value of the outstanding preferred stock?
(b) What will happen to price as the risk-free rate increases? Explain.
(a) Current value of the outstanding preferred stock = $100 × 0.10 / 0.115 = $86.96
(b) As the risk-free rate increases, the required rate of return will increase and the price will drop.
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