Two queations allocated, following, possible, between, whether

EastCoastJ

Guys, following ones are pestering me,

Is it possible to find out whether the value of a preferred share undervalued/overvalued and by how much if you are given Cost of Equity, Dividend, and Current Price?

Depreciation expense allocated between COGS and SG&A expenses does not affect the Operating Margin but affects the Gross Margin and Operating Expenses. Pls explain.

koba

Depreciation expense in COGS will arise when the company's inventories are actually "fixed asset" kind (e.g. A company selling sewing machine).

Matori

For no. 2, just plug in numbers and it will clear.
As soon as you allocate the depreciation expense between COGS and SG&A expenses , the Operating Margin does not change but the Gross Margin and Operating Expenses will decrease.

soddy1979

Hi Sasankm,

On the first one, going back to books, valuation of Preferred Stock can also be done as:

1. Taking them as perpetuity, as they pay a constant dividend perpetually. In this case, Price P of preferred stock would be = D / k, where k is cost of preferred stock equity.

2. By using constant growth dividend model. Only that growth rate can be taken as 0, as dividends are fixed year over year. In this case, Price of preferred stock P would be = D / (k - g) or = D / k as g is 0, which comes out to be same as that in 1.

So, yes, if we are given cost of Preferred Equity, Preferred Dividend amount and Current Price of Preferred Stock, we could find its valuation, compare that with the Current Price and know if it is overvalued or undervalued.

On the 2nd one, I agree with you. May be in the question it was asked to account for depreciation in GP and OP, just to test concepts.

rgonzalez

thanks rus1bus,

For the first one I do agree with you and I am also of the same opinion till I chanced upon a post titled "Request Preferred Shares and GP Margin" on 10th Dec 2008. Pls take a look at that, i could not follow that.

On the second one, thanks for the clarification, I know how COGS and SG&A are laid out in an Income Statement so I know the calculation of GP and Op too, but what foxed me is Depreciation appearing in COGS or SG&A , because Depreciation should ideally appear after Operating Profit along with amortisation to give us EBIT. pls correct me if i am wrong, as I am not an accounts student.

burnsy562000

To my understanding, value of preferred share is determined by the fixed coupon being paid on it and the current market interest rate + risk premium. Market price of preferred shares is determined in a similar way as that of a fixed income security. It should have nothing to do with Cost of Equity, Common Dividend payments or the Current Price of common stock.

To answer 2nd one:

COGS are expenses that you deduct from Revenues to get your Gross Income. And SG&A are expenses that you deduct from your Gross Income to get your Operating Income.

So, if you allocate depreciation to your SG&A, it will only affect your Operating Income. And if allocated to COGS, it will affect your Gross Income and your Operating Income.

I guess, this should not be difficult. Just put it down on paper in that sequence, and you will understand it.