Model for analyzing hybrid financing alternatives
In this model, we will examine four sources of long-term capital: preferred stock, leasing, warrants, and convertibles.
Preferred stock is a hybrid security that represents a cross between debt and common equity.
Leasing is used by
financial managers as an alternative to borrowing to finance fixed assets.
Warrants are derivative securities used by
Lastly, convertible securities are hybrids between debt and warrants.
Commonly, preferred stock has a par value of $25 or $100.
A preferred dividend is indicated as a percentage of par,
or as dollars per share.
Since preferred stock pays a perpetual dividend, its value is derived as the preferred dividend
divided by the cost of preferred stock.
Preferred stock's dividend yield, like common stock is the dividend paid
divided by the value of the stock.
A firm has sold 150,000 shares of $100 par value perpetual preferred stock (the total issue is $15 million).
preferred stock has a stated annual dividend of $12 per share.
What is the dividend yield?
Par value =
Leasing provides firms with a flexible alternative when it comes to acquiring productive assets.
assets and having them on the balance sheet, companies may opt to lease.
In 1997, about 30% of all new capital equipment
acquired by businesses was leased.
Leasing generally takes one of three forms: (1) sale-and-leaseback arrangements, (2)
operating leases, and (3) straight financial, or capital, leases.
A sale-and-leaseback arrangement is one whereby a firm
sells land, buildings, or equipment and simultaneously leases the property back for a specified period under specific
An operating lease is one in which the lessor maintains and finances the property. A financial lease does not
provide for maintenance services and is not cancelable.
This kind of lease is fully amortized over its life (and therefore is
also called a capital lease).
Financial Statement Effects
Lease payments are shown as operating expenses on a firm's income statement.
Under certain conditions, neither the
leased assets nor the liabilities under the lease contract appears on the firm's balance sheet.
For these reasons, leasing
is often called "off balance sheet financing".
This can be illustrated by looking at the hypothetical firms, B and L.
two firms are identical in every way, except Firm B has decided to buy its new assets, while Firm L has chosen to lease.
Before the increase in assets
Firms B and L