Preferred stock is said to be a hybrid of common stock and bonds. Explain fully. Describe the cash flows associated with preferred and their valuation.
Preferred stock does not have a maturity date, implying the firm is not responsible for paying dividends. Moreover, the dividends involved as not tax-deductible (Levi & Segal, 2015). However, preferred stocks and bonds are similar to the perspective that their dividends have a fixed amount. Unlike common stocks that are not paid regularly, preferred stocks are paid regularly and are associated with a fixed value. The value of a common stock is dependent on the growth rate of their dividends (Brigham, Ehrhardt, Nason, & Gessaroli, 2016). Preferred stocks are referred to as a hybrid because they have similar elements with bonds and common stocks.
Based on the type of exposure an investor seeks, preferred stock may be a good option. When a company issues a preferred stock it assigns a par value. The assigned value creates the base from which dividend payment schemes and cash flow valuation are calculated. Similar to any other form of investment, preferred stock investing should fit within an investor’s goals and timeline. If one expects to have more yield than a bond and incur less risk than stock, then preferred stock would be a suitable investment scheme. Preferred shareholders are considered to have priority over the company’s income, implying that they are paid dividends before payment is made to the shareholders.
Preferred stock may be considered as a hybrid of common stock and bonds because of their equity associated value. Preferred stock usually comprises of a fixed dividend payout, explaining why investors prefer them to bonds. Such types of stocks are approved on the company balance sheet within a shareholder’s equity column rather than on the debit column.
Brigham, E. F., Ehrhardt, M. C., Nason, R. R., & Gessaroli, J. (2016). Financial Management: Theory And Practice, Canadian Edition. Nelson Education.
Levi, S., & Segal, B. (2015). The Impact of Debt-Equity Reporting Classifications on the Firm's Decision to Issue Hybrid Securities. European Accounting Review, 24(4), 801-822.
by EssayRoyal, Dec. 7, 2019, 7:17 p.m.