Midsouth Exploration Company
Case 26
Preferred Stock
Purpose: The case allows the student to examine many of the attributes of preferred stock. Particularly
important is the cumulative feature when the company is in arrears, as well as a potential solution to that
problem. The tax consequences of preferred stock to the corporate recipient is also considered. The case
also provides a good opportunity to examine the comparative theoretical costs to the issuing corporation
of preferred stock and common stock.
Relation to Text: The case draws on material from Chapters 11, 15, and 17. Because some material is
related to dividends, the instructor may wait until after Chapter 18 to introduce the case (although such a
delay is not really necessary).
Complexity: The case is moderately complex and should require 1 hour.
Solutions
1. No, payment of dividends on preferred stock is not a contractual obligation (as is the payment
2. The annual dividend is $8.50 per share and the firm is 2 ½ years behind on the payment.
The answer is $21.25 ($8.50 + $8.50 + $4.25)
Arrearage per share
$21.25
Shares outstanding
x 200,000
Total arrearage
$4,250,000
3.
Arrearage per share
$21.25
Premium
x 150%
Price per new share
$31.875
Share price
$31.875
Percent dividend
9.2%
Cash dividend
$2.9325
4. Aftertax preferred yield = Before-tax preferred stock yield [1 – (Tax rate)(.30)]
5. Cost of preferred stock
$2.9325
9.2% (this value was previously stipulated)
p
pp
D
KPF
= = =
Cost of new common stock
1
0
$.50
9.75%
$25 $1.20
$.50 9.75% 2.10 9.75% 11.85%
$23.80
nD
Kg
PF
= + = =
−−
+ = + =
There are no tax benefits to the issuing corporation for either security (as would be true of the
payment of interest on debt).
6. Number of new shares of common stock:
ncorporatio the topriceNet
costspocket –of–out neededFunds
stock common of sharesnew ofNumber +
=
sharesnew008,271,1
80.23$
000,250,30$
20.1$25$
000,250$000,000,30$
==
−
+
=