Summary: Group 3 Aviles, Mia Colony M Bagot, Jerlin Bartolata, Neriza Joy

Preferred Stock Features Preferred stock differs from common stock because it has preference over common stock in the payment of dividends and in the distribution of corporation assents in the event of liquidation. Preference means only that the holders of the prefered shares must receive a dividend (in the case of an ongoing firm) before holders of common shares are entitled to anything. Preferred stock is a form of equity from a legal and tax standpoint. It is important to note, however, that holders of preferred stock sometimes have no voting priviliges. STATED VALUE: Preferred shares gas a stated liquidating value, usually $100 per share. The cash dividendis described in terms of dollars per share. CUMULATIVE AND NONCUMULATIVE DIVIDENDS A preferred dividend is not like interest on a bond. The Board of Directors may decide not to pay the dividends on preferred shares and their decision may have nothing to do with the current net income of the corporation. Preferred stock can either be cumulative or noncumulative. A cumulative preferred requires that if a company fails to pay any dividend or any amount below the stated rate, it must make up for it at a later time. Dividends accumulate with each passed dividend period, which can be quarterly, semi-annually, or annually. When a dividend is not paid in time, it has "passed" and all passed dividends on a cumulative stock is a dividend in arrears. A stock that doesn't have this feature is known as a noncumulative or straight preferred stock and any dividends passed are lost forever if not declared.

Cost of Preferred Stock Like common stock, preferred stock dividends are not tax-deductible. The only component in the cost of capital calculation that pays tax-deductible income is debt. Preferred stockholders do not have to be paid dividends, but the firm usually pays them. If they don't, they

can't pay dividends to their common shareholders and it is a bad financial signal for the firm to send out. Formula Kps = Dps/ NP = where: Kps= Component cost of preferred stock Dps = perpetuity (preferred dividend) NP= net issuing price or the price the firm receives after deducting the costs of issuing the stock, which are called flotation cost. F= the percentage (in decimal form) cost of issuing preffered stock P0 = current market price of the stock. Dps/ Po-Flotation costs = Dps/ Po(1-F)

Example:

Unilate plans to issue preferred stock that pays $12.80 dividend per share and sells for $120 per share in the market. It will cost 3% or $ 3.60 per share. What is the cost of preferred share?

Kps = Dps/ Po(1-F)

= $12.80/ $120 (1 - 0.03) = $12.80/ $116.40

Kps = 0.11 or 11%

No tax adjustments are made when calculating Kps because preferred dividends, unlike interest expense on debt, are not tax deductible, so there are no tax savings associated with the use of preferred stock.