I8.321 Unquoted preference shares and debentures
The investor in fixed interest securities is usually looking for security, and for this he is prepared to accept that inflation will prevent anything more than a small capital gain, which would come about if interest rates in general were to fall. This security is manifested in two ways—the assets cover and the earnings cover.
The adequacy of the assets cover is measured by the value and quality of the tangible assets. If the nominal value of the fixed interest securities is not sufficiently covered by the real net worth of the assets of the company, the value of the securities needs to be discounted accordingly. Similarly, if the earnings are not several times the amount required to meet the fixed interest payments, a higher yield is required. The amount of the cover required for safety in each case will depend upon the quality, as well as the extent, of the assets and the earnings cover. Preference shares and debentures in a large well established company will be more highly rated than those issued by a new untried company operating in a speculative trade.
Where two companies are of equal standing, their gearing can have an effect upon the value of their shares because, even if they have the same net assets and earnings, the one with less fixed interest (priority) capital in issue will have more cover for the benefit of its fixed interest members.
The only unknown would be the required dividend yield and HMRC