CORPORATE VALUATION SERVICES
STOCK OPTIONS
There are several common situations that require the valuation of preferred stock. The following situations give rise to this requirement:
- Purchase or sale for cash.
- Exchange of common equity or debt for preferred stock.
- Gift and estate taxes.
- Allocating total enterprise value among classes of securities.
- Adjusting a balance sheet for preferred stock owned or outstanding.
Additionally, there are several special characteristics of closely held preferred stocks such as dividend rate, liquidation preference, voting versus nonvoting as well as many others. The appraiser should be familiar with the implications of these characteristics before attempting to value preferred stock.
Revenue Ruling 83-120
This ruling discusses a number of issues to be considered when valuing preferred stock issues. This ruling was published before the advent of §2701 to §2704 that placed restrictions on the use of preferred stock issues to transfer wealth from-one generation to the next. Nonetheless, the ruling does provide helpful information to the analyst on the valuation of a preferred stock.
There are several factors to be considered when valuing preferred stock, including yield, dividend coverage, protection of liquidation, voting rights, and redemption privilege. Whether the yield of the preferred stock supports a valuation of the stock at par value depends in part on the adequacy of the dividend rate and whether the dividend is cumulative or noncumulative.
Dividend coverage is the risk that the corporation may be unable to timely pay the stated dividends on the preferred stock. It can be measured by the coverage of such stated dividends by the earnings of the company. Whether the issuing company will be able to pay the full liquidation preference at liquidation must be taken into account in determining the fair market value. This is the protection of liquidation. Voting rights, i.e., whether the preferred shareholders have voting rights and/or voting control, affects the value of the preferred stock. If the preferred shares have a redemption privilege, the nature and effect of this privilege should be taken into account.