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Disadvantages Of Preferred Stock Financing

The Best of Brian Tracy
Disadvantages of preferred stock financing from firm's viewpoint are as follows:

1. Preferred stock financing is expensive source of long-term financing because of two reasons:
i. Dividend rate on preferred stock is higher than interest rate payable on debentures.
ii. Unlike interest, preferred stock dividend is not tax-deductible expenses.

2. Preferred stock dividend is fixed and company must have commitment to pay this dividend. Although preferred stock dividends can be omitted, they may have to be paid because of their cumulative nature. Thus, preferred dividends are like fixed costs. The use of preferred stocks,like that of debt, increases financial risk and thus cost of common equity.

3. It is difficult to sell preferred stock in the market.Investors may not like to invest on preferred stocks because they get only fixed amount of dividend even though firm's earning is too high. Besides, if the earning of firm is low or unstable investors may not get preferred dividend. Hence, it is difficult to sell the stocks.

Disadvantages of preferred stock financing from investor's viewpoint are as follows:

1. As a general rule, preferred stockholders do not have voting right. Therefore, they have no control over management of company to protect their interest. 

2. Although preferred stockholders bear a substantial portion of ownership risk, they get limited return.

3. The preferred stockholders have no legally enforceable right to dividends.

4. The fluctuation in the price of preferred stock is wider than that of bonds. It exposes investors to higher price risk.

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