Investment Alternatives and Capital Budgeting Methodologies
Some companies’ common stocks pay cash dividends, while others’ do not. However, most bond issues do pay periodic interest. The preferred stock financing option also pays a dividend. Based on your readings, please respond to the following questions below:
From the investor’s point of view, analyze the advantages and disadvantages of the three investment alternatives—common stock, bonds, and preferred stock. Why would an investor select an investment in bonds over common stock, even if the return on the common stock investment is higher?
From the firm’s perspective, evaluate the pros and cons of using different combinations of debt, common stock, and preferred stock to raise funds. Why do some firms use preferred stock and others do not? Is it a matter of subjective preference, or are there sound theoretical reasons for the use of specific sources of funding?
How does an investor’s evaluation of the investment alternatives differ from the evaluation by a company trying to raise funds?
Among all the capital budgeting methodologies and their respective rules, which would you use and why? What are the advantages of one rule over another? Does the size or the nature of an investment have any impact on which method should be used? Why or why not? How might a rule be improved to make it more effective?