Paul Duncan, financial manager of EduSoft Inc., is facing a dilemma. The firm was founded 5 years ago to
provide educational software for the rapidly expanding primary and secondary school markets. Although
EduSoft has done well, the firm’s founder believes an industry shakeout is imminent. To survive, EduSoft must
grab market share now, and this will require a large infusion of new capital.
Because he expects earnings to continue rising sharply and looks for the stock price to follow suit, Mr. Duncan
does not think it would be wise to issue new common stock at this time. On the other hand, interest rates are
currently high by historical standards, and the firm’s B rating means that interest payments on a new debt issue
would be prohibitive. Thus, he has narrowed his choice of financing alternatives to (1) preferred stock, (2)
bonds with warrants, or (3) convertible bonds.
As Duncan’s assistant, you have been asked to help in the decision process by answering the following
questions.
a. How does preferred stock differ from both common equity and debt? Is preferred stock more risky than
common stock? What is floating rate preferred stock?
Sample Solution