Preferred stock valuation, Auditing

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Preferred stock valuation

1. Features of preferred stock (You may review what you've learned about preferred stock from TCA 221):

a. Multiple classes in terms of convertibility (into common stock) and protective provisions (in the event of bankruptcy).

b. Claim on assets and income before common stocks but after debts.

c. Stable dividends over time (like perpetuity).

d. Cumulative dividends - all past unpaid preferred dividends must be paid before any common stock dividends are declared.

e. Protective provisions - shareholder has voting rights in the event of nonpayment of dividends.

f. May have a retirement time frame - similar to maturity of the debt - hybrid security.

2. Valuation - similar to perpetuity (due to equal dividends over time)

Value of preferred stock (Vps):

Vps = annual dividend / RRR = D / Rps

Rps = RRR for the investor (discount rate for this preferred stock)

For example, a preferred stock pays $2 dividend annually and the investor's RRR is 10%. For the investor, the stock's value is $20 (2/0.1=20).

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