What are the advantages and disadvantages of preferred stock to the issuer?

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What are the advantages and disadvantages of preferred stock to the issuer?

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What are the advantages and disadvantages of preferred stock to the issuer?

Explanation & AnswerSolution by a verified expert

Explanation

The various advantages to the issuer for issuing preferred stocks are:

In case if the issuer fails to make a dividend payment due to the losses during the period, the issuer is not obligated to make such payments and cannot be forced by the stockholders towards bankruptcy.
When the preferred stock is sold, the existing common stocks are not diluted.
As in the case of a debt issue, a company is required to create a sinking fund for repayment of the principal. These repayment rules are not applicable in the case of preferred stock, even though they have a maturity period. This helps the company to reduce the usage of cash for such repayments and can use it for other purposes.

 
The disadvantages of issuing preferred stock are as follows:

The payment of dividend does not allow a company to have a tax deduction as in the case of debt issue, which makes the cost to issuer higher as compared to the debt issue.
The dividend payment on the preferred stock can be deferred to the next payment but still the company is obligated to pay it. This makes the dividend payment a fixed charge for the company and increases the financial risk of the company and eventually its cost of common equity.

Verified Answer

The advantages of issuing preferred stock to the issuer are:

The issuer cannot be forced for bankruptcy in case of non payment of dividends.
Dilution of common stock can be avoided.
Repayment obligation is not there in case of preferred stocks.

 
The couple of disadvantages of issuing preferred stock are:

The dividend payments are not tax deductible.
The payment of dividend is a fixed charge for the issuer even though it is sometimes deferred for a certain period.

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