Question

Preferred stock is said to be a hybrid of common stock and bonds. Explain fully. Describe the cash flows associated with preferred and their valuation

Answer 1

Answer:

Preferred stock shares the combined characteristics of common stock and bonds.

The cash flows associated with preferred stock are recorded in the financing activity section of the statement of cash flows.  The first is the receipt of cash (cash inflow) when preferred stock shares are issued.  The second is the payment of preferred stock dividends (cash outflow).

Explanation:

The characteristics of common stock shared by preferred stock are there is no fixed maturity date, no repayment of initial investment, preferred dividends do not force the company into bankruptcy, and dividends are not deductible for tax purposes.  The characteristics of bonds that preferred stock shares are fixed interest rate, preferential treatment in liquidation and in the payment of dividends, and non-participation in the residual profits.