Chapters 17

Chapters 17

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2. Text-Messaging Inc. has $72 million in earnings and is considering paying $8.35 million in interest to bondholders and $6.65 million in dividends to preferred stockholders.

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??a.) What are the bondholder???s contractual claims to payment? (You may wish to review Table 17-3 on page 550.)??

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b.) What are the preferred stockholders??? immediate contractual claims to payment? What privileges do they have???

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18. The Omega Corporation has some excess cash that it would like to invest in marketable securities for a long-term hold. Its vice-president of finance is considering three investments (Omega Corporation is in a 35 percent tax bracket and the tax rate on dividends is 15 percent). Which one should she select based on aftertax return: (a) Treasury bonds at a 9 percent yield; (b) corporate bonds at a 12 percent yield; or (c) preferred stock at a 10 percent yield?

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19. National Health Corporation (NHC) has a cumulative preferred stock issue outstanding, which has a stated annual dividend of $9 per share. The company has been losing money and has not paid preferred dividends for the last five years. There are 300,000 shares of preferred stock outstanding and 600,000 shares of common stock.

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a.) How much is the company behind in preferred dividends?

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b.) If NHC earns $11,000,000 in the coming year after taxes but before dividends, and this is all paid out to the preferred stockholders, how much will the company be in arrears (behind in payments)? Keep in mind that the coming year would represent the sixth year.

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c.) How much, if any, would be available in common stock dividends in the coming year if $11,000,000 is earned as explained in part b?

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22. The treasurer of Kelly Bottling Company (a corporation) currently has $100,000 invested in preferred stock yielding 8 percent. He appreciates the tax advantages of preferred stock and is considering buying $100,000 more with borrowed funds. The cost of the borrowed funds is 10 percent. He suggests this proposal to his board of directors. They are somewhat concerned by the fact that the treasurer will be paying 2 percent more for funds than the company will be earnings on the investment. Kelly Bottling is in a 34 percent tax bracket, with dividends taxed at 15 percent.

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a.) Compute the amount of the aftertax income from the additional preferred stock if it is purchased.

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b.) Compute the aftertax borrowing cost to purchase the additional preferred stock. That is, multiply the interest cost time (1 ??? T).

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c.) Should the treasurer proceed with his proposal?

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d.) If interest rate and dividend yields in the market go up six months after a decision to purchase is made, what impact will this have on the outcome?

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23. Barnes Air Conditioning, Inc., has two classes of preferred stock: floating rate preferred stock and straight (normal) preferred stock. Both issues have a par value of $100. The floating rate preferred stock pays an annual dividend yield of 6 percent, and the straight preferred stock pays 7 percent. Since the issuance of the two securities, interest rates have gone up buy 2 percent for each issue. Both securities will pay their year-end dividend today.

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a.) What is the price of the floating rate preferred stock likely to be?

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b.) What is the price of the straight preferred stock likely to be? Refer back to Chapter 10 and use Formula 10-4 on page 297 to answer this question.

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Chapter 18

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