Question

Bolster 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, Mike O'Brian, and the vice president of finance, John Ibison:

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

John: 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 rates either this month or next.

Mike: 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.

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

Mike: 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.

REQUIRED: Discuss the advantages and disadvantages of issuing preferred stock versus bonds. Remember the company is issuing the bonds, be sure to discuss this from the Company's point of view not the investor's point of view.

a. You must have a source within your reply. You may use the book as your reference, but DO NOT copy information word-for-word. You also have the option to use another source. (2 points)

b. There must be at least two advantages and two disadvantages listed with supporting information. (from company's point of view, who is issuing the bonds or stock not investors) (2 points)

c. Your comments should at least be a paragraph and well thought out. (1 point)

Answer 1

Bolster Inc. has decided to expand its operations to owning and operating car washes.

The conversation between the chief executive officer, Mike O'Brian, and the vice president of finance, John Ibison they have two options to raise fund i.e Prefered shares or Bonds. Because of equity market is little depressed this time so they decided to issue Bonds and the bond market is strong this time.

Comparison between Prefered stocks and Bonds from the Company's point of view.

PREFERED STOCKS : Preference shares are comonly known as the Preferred stocks.These are used for long term source of funding.They have right to recieve dividend before common stock dividend and also the company is entitled to repay capital before common stock at the time of closure/bankruptcy/liquidation. The preferred stock holders have partial ownership right in the company they do not vote in the company unless required.

ADVANTAGES

1) No legal obligation for dividend payment for preferred stocks in case there is no profit.

2) It Improves borrowing capacity as they are not treated as debt.

3) No dilution in control because there is partial ownership right.

4) When comapny issues preferred stocks there will be no charge created on assests.

DISADVANTAGES

1) Skipping dividend disregards market image.

2) Preference in claims. They have priority in both regards to dividend as well as capital.

BONDS : Bonds are the debt security where an issuer is bound to pay a specific rate of interest agreed as per the terms of payment and repay principal amount at a later time.The holders of bond generally like a creditors where the company has obligation to pay the amount.

ADVANTAGES

1) Issuer can issue bonds for finance without dealing with banks making less expensive.

2) Can borrow large amount of fund through single transaction.

3) If rate of interest is low that leads to decline in cost of bonds.

4) No ownership of bond holders.

5) Principal amount will be repay at a later time.

DISADVANTAGES

1) Company has obligation to pay fixed rate of interest or coupon payment.

2) Creation of charge on physical assest.

3) Creation of laibility.

John and mike decided to issue bonds beacuse the bond market is strong that means there may be less interest payment so it will lead to or decrease the company's cost of bond for finance. As we discussed above the advantages and disadvantages of preferred stock versus bonds, according company has to choose preferred stocks because they are more advantageous to bonds. But in the given situation we have provided that there is strong or good market for the bonds so we will prefer bonds financing over preferred as the MIKE and JOHN decided . It may give less cost to company for raising finance from bonds over preferred without diluting the ownership.