end of the current year. For mature firms or declining firms, deferred tax liabilities can be
treated as an interest-free debt from the government (Internal Revenue Service) that may be
repaid in the near future. However, for rapidly growing firms, deferred taxes are unlikely to
reverse any time soon, making it more like equity.
may be treated as equity. Despite the fact that preferred stock offers a fixed
dividend like debt, the payment of dividend depends on management’s discretion. When the
company is seriously short of cash, management can decide to pay the preferred stock
dividend in the next period. Like common stock, preferred stock does not have a final
principal payment date. Also, preferred stockholders cannot force the company that skipped
dividends to bankruptcy.
gives its owner the option to exchange the bond for a predetermined number
of common shares at a fixed price. When the convertible debt holders decide to exercise their
option to buy common stock, they just exchange the convertible debt with common stock.
Convertible debt is treated as debt until it is converted to common stock.
U.S. public companies with “low” leverage have an interest
-bearing net debt-to-equity
ratio of 0 percent or less, firms with “medium” leverage hav
e a ratio between 1 and 62
percent, and “high” leverage firms have a ratio of 63 percent or more. Given these data, how
would you classify the following firms in terms of their optimal debt-to-equity ratio (high,
medium, or low)?