An investor gathered the following data:
Par value of preferred stock offered with a 6% dividend rate $100
Company’s sustainable growth rate 5%
Yield on comparable preferred stock issues 11.5%
Investor’s marginal tax rate 30%
The value of the company’s preferred stock is closest to:
a.$96.92.
b.$54.78.
c.$52.17.
Answer is c as they use D0 (6/11.5%)=52.17 instead of D1 (6*1.05)/11.5%=54.78
Why is that? I read in the forum that the reason is that the growth is constant (?) and therefore 0 (/www.analystforum.com/t/when-to-use-gordon-growth-model/115119) but the rationale does not convince me…
In other instances we use the sustainable growth rate as basis to calculate the forward Dividend… so why not here?
Thanks