Beacon Inc. has decided to expand its operations to owning and operating long te
ID: 2347328 • Letter: B
Question
Beacon Inc. has decided to expand its operations to owning and operating long term health care facilities. The following is an excerpt from a conversation between the chief executive officer, Frank Forrest, and the vice president of finance, Rachel Tucker.
Frank: Rachel, have you given any thought to how we’re going to finance the acquisition of St. Seniors Health Care?
Rachel: Well, the two basic options, as I see it, are to issue either preferred stock or bonds. The equity market is a little depressed right now. The rumor is that the Federal Reserve Bank’s going to increase the interest rate either this month or next.
Frank: Yes, I’ve heard the rumor. The problem is that we can’t wait around to see what’s going to happen. We’ll have to move on this next week if we want any chance to complete the acquisition of St. Seniors.
Rachel: Well, the bond market is strong right now. Maybe we should issue debt this time around.
Frank: That’s what I would have guessed as well. St. Senior’s financial statements look pretty good, except for the volatility of its income and cash flows. But that’s characteristic of the industry.
Discuss the advantages and disadvantages of issuing preferred stock versus bonds.
Explanation / Answer
Advantages From Company’s standpoint
The bonds get interest at a fixed rate, whereas the common stock gets the dividends as per the availability of Net Income. If the Earnings per share are more, the company has to distribute more dividends.
Bonds may be cumulative or non-cumulative and the company has the fixed known liability to pay as interest, for the specified period, as agreed. Stock will have indefinite life, and the company will distribute the dividends, for till dissolution / liquidation.
Bonds are a loan to the company, whereas the stock is not a loan, it is a capital.
Bonds are issued for a fixed period, whereas stock is usually for the life of the company.
Common stock has a voting right, whereas Bonds do not have voting rights.
Advantages From Investor’s standpoint
The bonds get interest at a fixed rate, whereas the common stock gets the dividends as per the availability of Net Income. If there is net income after payment to bond holders, then only the company distributes dividends to common stock.
Bonds may be cumulative or non-cumulative and the company has the known liability to pay as interest, for the specified period, as agreed. Stock will not have guarantee to get the dividends, and for what period. Business is uncertain. There may be rise and fall. So when fall will come and what will be dividends to common stock, no one can be certain.
Bonds are a loan to the company, whereas the stock is not a loan, it is a capital. Hence the investor becomes a part of the company’s management.
In case of liquidation, bond holder get priority in distribution of funds, where as the common stock holder stands last, will get only if there is some funds left.
Bonds are issued for a fixed period, whereas stock is usually for the life of the company. Therefore, bond holder is certain to get back the invested money after the term is over, but common stock holder will never get the invested funds back till liquidation.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.