Question

US Inc. has decided to expand its operations to owning and operating car washes. The following is an excerpt from the conversation between the chief executive officer, John Porter and the vice president of finance, Mc.Call :

John : Mc.Call, have you given any thought to how we're going to manage the acquisition of Swiffer Car Wash?

Mc.Call: 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 BOA Bank's going to increase the interest rates either this month or next.

John : 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 Swiffer Car Wash.

Mc.Call: Well, the bond market is strong right now. Maybe we should issue debt this time around.

John: That's what I would have guessed as well. Swiffer Car Wash's financial statements look pretty good, except for the volatility of it's income and cash flows. But that's characteristic of the industry.

Discuss the advantages and disadvantages of issuing preferred stock versus bonds.

Answer 1

Preferred Stock	Bonds
Advantages	Advantages
1. Preferred Stockholders will get fixed dividend payments regardless of how the company will performs.	1. The Volatility of Bonds is lower than that of Stocks which short & medium dated bonds.
2. As a preferred stockholder, you can be assured a claim on company assets.	2. The Bondholders also enjoy a measure of legal protection under different Countries.
3. There is low risk compared to other forms of investment even in adverse situations the company fails to make profits, they are required to pay dividends.	3.The company goes into bankrupt, the bondholders will often receive some money back.
Disadvantages	Disadvantages
1. Preferred stocks entitle you to get fixed dividend payments that don’t increase in stocks value.	1 Bonds are subject to various risks such as call and prepayment risk.
2. Preferred stockholders don’t enjoy the voting rights in company.	2 Bond prices can become volatile depending on credit rating of issuer.