Hybrid Financing

Prepared by:Jammie Ann Felipe

Preferred Stock

• A hybrid form of financing• A type of stock that promises a

(usually) fixed dividend but at a discretion of the board of directors.

• It has preference over a common stock in the payment of dividends and claims on asset (but up to a maximum of Par Value of the stock)

Preferred Stock and its Features

• Cumulative Dividends Feature

- A requirement that all cumulative unpaid dividends on the preferred stock be paid before a dividend may be paid on the common stock.

Preferred Stock and its Features

• Participating Feature - allows preferred stockholders to participate in the increasing dividends if the common stockholders receive increasing dividends.

Preferred Stock and its Features

• Voting Rights (In Special Situations) - Given usually if corporation is unable to pay preferred stock dividends during a specified period.

Advantages of Preferred Stock

• 1. Passing a preferred dividend cannot force a firm into bankruptcy, whereas failure to pay interest on a bond can lead to bankruptcy.

• 2. By issuing preferred stock, the firm avoids the dilution of common equity that occurs when common stock is sold.

Advantages of Preferred Stock

• 3. Since preferred stock sometimes has no maturity and since preferred sinking fund payments, if present, are typically spread over a long period, preferred issues can reduce the cash flow drain from repayment of principal that occurs with debt issues.

Disadvantages of Preferred Stock

• 1. Preferred stock dividends are not deductible to the issuer; consequently, the after-tax cost of preferred is typically higher than the after-tax cost of debt.

Disadvantages of Preferred Stock

• 2. Although preferred dividends can be passed, investors expect them to be paid and firms intend to pay the dividends if conditions permit. Thus, preferred dividends are considered a fixed cost. Therefore, their use, like that of debt, increases the firm’s financial risk and thus its cost of common equity.

Common Stock vs. Preferred Stock

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