chap15_quest - CHAPTER 15 LONG-TERM FINANCING: AN...

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CHAPTER 15 LONG-TERM FINANCING: AN INTRODUCTION Answers to Concepts Review and Critical Thinking Questions 1. The indenture is a legal contract and can run into 100 pages or more. Bond features which would be included are: the basic terms of the bond, the total amount of the bonds issued, description of the property used as security, repayment arrangements, call provisions, convertibility provisions, and details of protective covenants. 2. The differences between preferred stock and debt are: a. The dividends on preferred stock cannot be deducted as interest expense when determining taxable corporate income. From the individual investor’s point of view, preferred dividends are ordinary income for tax purposes. For corporate investors, 70% of the amount they receive as dividends from preferred stock are exempt from income taxes. b. In case of liquidation (at bankruptcy), preferred stock is junior to debt and senior to common stock. c. There is no legal obligation for firms to pay out preferred dividends as opposed to the obligated payment of interest on bonds. Therefore, firms cannot be forced into default if a preferred stock dividend is not paid in a given year. Preferred dividends can be cumulative or non-cumulative, and they can also be deferred indefinitely (of course, indefinitely deferring the dividends might have an undesirable effect on the market value of the stock). 3. Some firms can benefit from issuing preferred stock. The reasons can be: a. Public utilities can pass the tax disadvantage of issuing preferred stock on to their customers, so there is a substantial amount of straight preferred stock issued by utilities. b.
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This note was uploaded on 02/14/2011 for the course FINANCE 620 taught by Professor Halstead during the Spring '09 term at UMBC.

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chap15_quest - CHAPTER 15 LONG-TERM FINANCING: AN...

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