Finance 301 Chapter 7

Parrot Transport Corp. currently pays preferred stockholders a dividend of $1.50 per share and common stockholders a dividend of $1.00 per share. If the firm wants to raise the common stock dividend to $2.00 per share, it will also have to raise the preferred stock dividend to $2.00 per share. Which type of provision does Parrot have in its preferred stock agreements?

A Participating Provision

Sinking fund

Most newly issued preferred stocks have sinking funds that call for the repurchase and retirement of a given percentage of the preferred stock each year. By including a call provision with a sinking fund, a firm essentially adds a maturity option to a preferred stock issue, because it is likely that the issue will be called and retired by the firm at some future date.

For the same issuing firm and on the same day of issuance, which security tends to have a greater after-tax cost to the issuer, debt or preferred stock? Why is this the case?

Preferred stock, because its dividend payments are not tax deductible

Call provision

gives the issuing corporation the right to call in the preferred stock for redemption. As in the case of bonds, call provisions generally state that the company must pay an amount greater than the par value of the preferred stock, with the additional amount being dubbed a call premium.

Participating

A rare type of preferred stock is one that participates with the common stock in sharing the firm's earnings. Participating preferred stocks generally work as follows. (a) The stated preferred dividend is paid—for example, $5 per share. (b) The common stock is then entitled to a dividend in an amount up to the preferred dividend. (c) If the common dividend is raised, say, to $5.50, the preferred dividend must likewise be raised to $5.50.

Purple Pigeon Bird Seed Company is required to repurchase and retire 5% of its preferred stock each year. Which type of provision does Purple Pigeon have in its preferred stock agreements?

A sinking fund provision

Debt or Common Stock Failure to pay its dividend does not send the firm into bankruptcy.

Common Stock

Debt or Common Stock Usually has no specified maturity date

Common Stock

Debt or Common Stock It has a par, or face, value.

Debt

Debt or Common Stock Its dividends are fixed in amount.

Debt

Debt or Common Stock Usually has no voting rights

Debt

Debt or Common Stock? May have a sinking fund provision

Debt

For the same issuing firm and on the same day of issuance, which security tends to have a lower after-tax cost to the issuer, debt or preferred stock? Why is this the case?

Debt, because its interest payments are tax deductible