Preferred stock is an equity investment with features that give its holders priority over common stockholders in certain situations. This lesson explores how preferred stock works and how it differs from common stock.
Preferred stock is a class of equity that gives its holders preferential claims, especially for dividends and distributions if a company is liquidated. Preferred stockholders generally receive dividends before common stockholders receive any dividends. If a firm is liquidated, preferred stockholders generally have a claim ahead of common stockholders, but behind creditors.
All flashcards
What is preferred stock?
A class of equity that typically provides a stated dividend and priority over common stockholders for dividends and liquidation distributions.
What are dividends in arrears?
Accumulated unpaid dividends on cumulative preferred stock, generally payable before common stockholders can receive dividends.
How do cumulative and noncumulative preferred stock differ?
Missed dividends on cumulative preferred stock accumulate; missed dividends on noncumulative preferred stock generally do not.
What is convertible preferred stock?
Preferred stock whose terms allow holders to convert shares into a specified number of common shares.
How is a constant preferred dividend valued in the no-growth perpetuity model?
Divide the expected annual dividend by the required annual return: Pp=Dp/rp.
Quiz questions
A preferred share pays $60 annually, and investors require an 8% annual return. What is its estimated value under the no-growth perpetuity model?Answer: $750, calculated as $60 divided by 0.08.
A preferred share pays $50 annually and sells for $500. What required annual return is indicated by the constant-dividend model?Answer: 10%, calculated as $50 divided by $500.
If a preferred share's expected annual dividend stays constant, what happens to its estimated value when the required return rises?Answer: The estimated value decreases.
Which assumptions support using the basic perpetuity model for preferred-stock valuation?Answer: A constant dividend continues indefinitely, with no growth.
A preferred share has $1,000 par value, a 5% annual dividend rate, and a 10% required return. Why is its estimated perpetuity value below par?Answer: The $50 annual dividend is small relative to the 10% required return.
Based on Principles of Finance by Julie Dahlquist, Rainford Knight (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.