Chapter 8 Homework solutions

Chapter 8 Homework solutions - CHAPTER 8 Stock Valuation...

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CHAPTER 8 Stock Valuation Homework Solutions ANSWERS TO END-OF-CHAPTER QUESTIONS 8-1. Preferred stock is often referred to as a hybrid security. This is because preferred stock has many characteristics of both common stock and bonds. It has characteristics of common stock, such as no fixed maturity date, nonpayment of dividends does not force bankruptcy, and the nondeductibility of dividends for tax purposes. But it is like bonds because the dividends are fixed in amount like interest payments. From the point of view of the preferred stockholder, this is not the most advantageous combination. On one hand, the dividends are limited as with bond interest, but the security of forced payment by the threat of bankruptcy is not there. Thus, from the point of view of the investor, the worst features of common stock and bonds are combined. 8-2. To a certain extent, preferred stock dividends can be thought of as a liability. The major difference between preferred dividends in arrears and normal liabilities is that nonpayment of them cannot force the firm into bankruptcy. However, since the goal of the firm is common shareholder wealth maximization, which involves getting money to the common shareholders (dividends), preferred arrearages provide a barrier to achieving this goal. 8-3. A cumulative feature requires all past unpaid preferred stock dividends be paid before any common stock dividends are declared. A stockholder would like preferred stock to have a cumulative dividend feature because without it there would be no reason why preferred stock dividends would not be omitted or passed when common stock dividends were passed. Since preferred stock does not have the dividend enforcement power of interest from bonds, the cumulative feature is necessary to protect the rights of preferred stockholders. Other frequent protective features serve to allow for voting rights in the event of
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This note was uploaded on 02/20/2010 for the course FIN 565 taught by Professor Libnitz during the Spring '10 term at Academy of Design Tampa.

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Chapter 8 Homework solutions - CHAPTER 8 Stock Valuation...

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