22. Preferred Stock

Convertible feature

Feature allowing preferred stock shareholders can exchange preferred stock for common stock according to specified exchange ratio.

Call feature

Feature allowing the issuer the right to buy back the preferred stock, normally at a premium.

Preferred stock valuation formula

preferred stock value = dividend payment / required rate of return

Disadvantages of preferred stock financing (4)

1. dividend expecations are high 2. dividend payments are not tax deductible 3. if triggered, protective provisions may become onerous 4. generally, a higher cost of capital than bonds.

Attributes of preferred stock (5)

1. grants ownership interest 2. has no maturity date 3. does not require dividends be paid 4. provides that dividends paid are not an expense are not tax deductible 5. has liability that is limited to the amount of the investment

Advantages of preferred stock financing (5)

1. no legally required dividend payments; default cannot result from failure to pay dividends 2. generally lower cost of capital than common stock 3. generally does not bestow voting rights 4. no maturity date 5. no security required

Preferred stock

A class of ownership in a corporation that has a priority claim on its assets and earnings before common stock, generally with a dividend that must be paid out before dividends to common shareholders are paid.

Participating feature

Allows preferred shareholders receive dividends in excess of the stated preference rate.

Cumulative feature

Dividends not paid in any year accumulate and require payment before payment of common dividends.