What is the intrinsic value of a preference share that has been paying a semi-annual dividend of $1.7 per share, and has an equity cost of capital equal to 13.2% p.a. compounding annually?
Question
What is the intrinsic value of a preference share that has been paying a semi-annual dividend of $1.7 per share, and has an equity cost of capital equal to 13.2% p.a. compounding annually?
Solution
The intrinsic value of a preference share can be calculated using the formula for the present value of a perpetuity. A perpetuity is a type of annuity that pays forever. The formula is:
Intrinsic Value = D / r
where: D = Dividend per period r = Discount rate per period
In this case, the dividend is paid semi-annually, so we need to adjust both the dividend and the discount rate to reflect this.
Step 1: Adjust the dividend Since the dividend is paid semi-annually, the dividend per period is $1.7.
Step 2: Adjust the discount rate The equity cost of capital is given as 13.2% per annum. Since there are two periods in a year, the discount rate per period is 13.2% / 2 = 6.6%.
Step 3: Calculate the intrinsic value Now we can substitute these values into the formula:
Intrinsic Value = 25.76
So, the intrinsic value of the preference share is approximately $25.76.
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