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13 Cards in this Set
- Front
- Back
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In what ways is preferred stock similar to bonds? |
-the dividend amount (like interest) is limited in amount
-preferred stock does not have voting rights
-value of PV of expected future cash flows
-ROR expected on the investment |
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In what ways is preferred stock similar to common stock? |
-grants ownership interest
-has no maturity date
-does not require dividends to be paid
-provides that dividends paid are not an expense (and are not deductible)
-liability is limited to the amount of investment |
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What characteristics make preferred stock different from common stock? |
-firm can have different classes of preferred stock
-cumulative/noncumulative feature
-protective provisions for shareholders' interest i.e. right to vote in some situations
-convertible/nonconvertible feature
-call provision |
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Preferred Stock: describe cumulative vs. noncumulative feature |
distinguishes whether preferred shareholders receive dividends in excess of the stated preference rate |
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Preferred Stock: describe convertible vs. nonconvertible feature |
distinguishes whether shareholders can exchange preferred stock for common stock for a specific exchange rate |
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Preferred stock: describe the call provision |
gives the firm the right to buy back the preferred stock at a premium |
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What 3 things are used to estimate the value of preferred stock? |
-estimated future annual dividends
-discount rate in the form of investors' ROR
-assumption that the dividend stream will exist in perpetuity |
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Theoretically, how do you calculate the value of preferred stock? (PSV) |
PSV = Annual Dividend / ROR |
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How can you calculate the currently expected ROR derived from preferred stock? (PSER) |
PSER = Annual Dividend / Market Price
*measure of the firm's current cost of preferred stock capital; rate that investors currently require |
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What are the advantages of preferred stock? |
-no legally required periodic payments (no default for not paying dividends)
-lower cost of capital than common stock
-does not bestow voting rights
-no maturity date
-no security required |
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What are the disadvantages of preferred stock? |
-dividend expectations are high
-dividend payments are not tax-deductible
-if triggered, protective provisions can be onerous
-higher cost of capital than bonds |
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What happens to a firm's long-term debt when preferred stock is issued? |
no change |
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What happens to a firm's debt-to-equity ratio when preferred stock is issued? |
decreases |
