Question
The Melano Corporation was authorized to issue 1,000,000 shares of $1 par common stock and 100,000 shares of $100 par, 10 percent cumulative preferred stock. To date, Melano has issued 300,000 shares of common stock and no preferred stock. Melano is contemplating the acquisition of a new plant and wants to issue stock to raise the $1,000,000 cash to finance its acquisition. The company is trying to decide whether to issue 25,000 shares of common stock or 10,000 shares of preferred stock. Describe the advantages and disadvantages of issuing each type of stock.
Explanation / Answer
Ayuthorized shares of common stock= 1,000,000 Authorized shares of Preferred stock = 100,000 Till date, Melano has issued 300,000 shares of common stock. Value of common stock = Number of shares issued * Par value per share = 300,000 * $1 = $300,000 The company wants to raise $1,000,000 cash to finance its acquisition. The company is deciding whether to issue 25,000 shares of common stock or 10,000 shares of preferred stock. Advantages and disadvantages of issuing common stock: Advantages: 1) Because common stock represents the owners equity of the company, issuing common stock will create more value to the company. 2) Since dividends on common stock are not fixed, the company has the advantage of making profits. 3) Due to the potential growth prospects of common stock, the company can issue to attract more number of shareholders. Disadvantages: 1) If the company issues common stock it has to issue 25,000 shares but for preferred it can issue just 10,000 shares due to the par value of the share. Advantages and Disadvanatages of issuing Preferred stock: 1) Since the par value of the stock is more, the company can raise the $1,000,000 by just issuing 10,000 shares. 2) The company can attract more number of shareholders due to the fixed dividend income. Disadvantages: 1) Since the stock is cumulative, the company is obligated to pay the preferred dividends before any other payments are made. 2) The preferred shareholders have the rights and they should be given the first preference at the time of liquidation.