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FINANCIAL MANAGEMENT FIN 200

Preferred Stocks and Common Stocks

Question-1: What is the difference between preferred Stocks and common stocks?. Are preferred Stocks riskier than common Stocks? Why?

SAMPLE ANSWER:

The difference between preferred stock and common stocks are:-

1) Dividends paid by preferred stock are bigger than paid by common stock.

2) Preferred stock owners receive pre-defined payments whereas decision of the common stock owners depends on the decision of the board of directors.

3) The investors of preferred stock are guaranteed fixed dividend forever and sometimes variable whereas common stock investors have variable dividends.

4) Preferred stockholders experience the financial trouble and liquidated, it would be paid before the common stockholders.

5) Common stockholders enjoy voting rights whereas preferred stocks do not get any voting rights.

Preferred stocks are less riskier than common stock because if the company goes bankrupt the preferred shareholder is more likely than common stockholders. As the company liquidates, preferred stockholders are paid before the common stockholders.

Question-2: what do you understand by WACC? Does capital structure affect the cost of capital? Give examples to support your answer.

Question-3:  Describe the difference between the discounted dividend model and corporate valuation model for valuation of stocks. Highlight the common features between the two models.

Question-4  Use the following information for answering the questions (a) and (b)

ABC Corporation started business in 2005. The growth rate for the first 4 years was exceptional i.e. 25% per year. After the fourth year the growth rate became constant at 6 percent. The treasury bills offer 5%, while market offers on investment equal 12%. The beta for the company is 0.85. Investment consists of $35 million, and equity consists of 8 million preferred stocks and 19million common stocks. The latest dividend issued was $4 . The free cash flow stream for the last 5 years have been -2million, 3 million. 3.5million, 5 million and 10million. The company paid taxes at the rate of 35% on its

  1. Calculate the stock value for year-1 using the discounted dividend model.
  2. What is the dividend yield and capital gains yield.

Is the stock value that you get by using Discounted Dividend model different from the value obtained using Corporate Valuation Model?

Question-5. You earned $4 in dividend from a company which is growing at  5%. If the market rate is 13% and the beta of the company is 1.25 , what is the value of the share you are holding.?

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