Financial Management: Theory and Practice Assignment Help
Paul Duncan, financial manager of EduSoft Inc., is facing a dilemma. The firm was founded 5 years ago to provide educational software for the rapidly expanding primary and secondary school markets. Although EduSoft has done well, the firm's founder believes an industry shakeout is imminent. To survive, EduSoft must grab market share now, and this will require a large infusion of new capital. Because he expects earnings to continue rising sharply and looks for the stock price to follow suit, Mr. Duncan does not think it would be wise to issue new common stock at this time. On the other hand, interest rates are currently high by historical standards, and the firm's B rating means that interest payments on a new debt issue would be prohibitive. Thus, he has narrowed his choice of financing alternatives to: (1) preferred stock, (2) bonds with warrants, or (3) convertible bonds.
As Duncan's assistant, you have been asked to help in the decision process by answering the following questions.
1. How does preferred stock differ from both common equity and debt? Is preferred stock more risky than common stock? What is floating rate preferred stock?
2. How can knowledge of call options help a financial manager to better understand warrants and convertibles?
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Answer no 1
Preferred stock is considered as a hybrid which consist features similar to both the equity (common stock) and debt. Similarly to debt, preferred stock imposes fixed dividends to the investors (Linsmeier, Partridge and Shakespeare, 2018). Preferred does not provide any voting rights to the investors and thus the dividends non payments does amount to bankruptcy and default prior to common stock. On the other hand, similar to equity, preferred stock payments are well thought-out dividends from both tax and legal standpoints, with no maturity date and conceded on the equity section of the company balance sheet (Linsmeier, Partridge and Shakespeare, 2018).
Additionally the dividends of the preferred stocks are cumulative and are accumulated without interest and are to be paid before the common stock payment (Linsmeier, Partridge and Shakespeare, 2018). From the viewpoint of the creditor the preferred stock in a great way is common stock, but from the standpoint of a common investor preferred stock is more as like debt.
Preferred profits are commonly aggregate; that is, profits that are overlooked amass (without intrigue) and should be paid before any regular profits can be paid. At long last, favored investors can regularly choose a few chiefs whenever preferred profits are precluded for some period, by and large three continuous quarters (Linsmeier, Partridge and Shakespeare, 2018). Along these lines, favored stock lies somewhere close to regular value and obligation in the hazard/return range.
Floating rate preferred stock have the payment of the dividend that are associated to the rates on the capital securities where the dividend are fluctuating and is based on the rate of treasury instrument. Hence, it is for all time trades at equality. Such preferred stocks are known as the floating rate preferred stock (Boudry, deRoos and Ukhov, 2016).
Answer no 2:
Call options is one type of contract where one of investor is given with the right and no obligation to sell or buy any defined stock at some fixed price and within certain specific time frame. Convertibles construct into an indirect call option and warrants are the long term options. Both provide the investor with right but not with the option of converting or acquiring the specific stock at a specific price time frame (Boudry, deRoos and Ukhov, 2016). Options knowledge helps the financial managers to understand the pricing strategy of convertibles and warrant; circumstances where the options with convertibles and warrants are exercised have better impact on the company decisions (Boudry, deRoos and Ukhov, 2016).
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