Question

1. All of the following are characteristics of preferred stock that make it similar to bonds except:

a. constant periodic payments

b. ahead of common stock with respect to dividends

c. no voting rights

d. periodic payment is tax deductible to the paying company

e. all of the above

2. Which of the following, holding all other variables constant, will cause an INCREASE in a constant growth stock's current value?

a. increase in the growth rate

b. increase in the market return (k)

c. increase in number years stock is held

d. both a & b

e. all the above

3. How is preferred stock similar to bonds?

a. constant payment

b. pays both principal and interest to investor

c. fixed maturity date

d. both a & c

e. all the above

Answer 1

Ans. 1 is d. periodic payment is tax deductible to the paying company. The interest payable to the bondholders is tax deductable while the fixed rate of dividend paid to preferred shareholders is not tax deductable. It is paid after the tax gets deducted from the taxable income.

Ans. 2 is a Increase in growth rate. Since the formula is P0 = D1 / (r -g), where g is growth rate. Increase in growth rate will reduce the denominator as a result the the vaue of the stock will increase.

Ans. 3 is a. constatnt payment. As in case of debentures interest is paid to the bondholder, the preferred shareholders are paid with the contatnt dividend at a fixed rate.