The Canadian Queen’s Bank of Industry Ltd. is a large national Canadian bank. It has significant expansion opportunities. However, its ability to raise additional debt capital from bonds or debentures is restricted because of the debt/equity regulations of Canada’s Bank Act.
The bank has decided to issue preferred shares. The financial highlights of the prospectus are as follows:
Proposed issue
4,000,000 floating rate, class A preferred shares (cumulative, redeemable, and without par value).
Price $100 per share.
Dividends
Dividends will be payable monthly. The dividend rate will float in relation to changes in the prime interest rate as set by the bank. The initial annual dividend rate will be equal to 2⁄3 prime plus 1⁄2% per annum. As dividends will accrue and be payable monthly, the normal dividend payment will be 1⁄12 of the annual rate.
Redemption
The shares will be redeemable at the option of the bank in whole or in part from time to time.
At the time the prospectus was issued, the bank published the following interest rates for its customers:
Prime lending rate ………………………….…….......              7.5%
Savings account (interest monthly) …………..…             3.0
One-year term deposits …………………….………….           6.0
30-day term deposits ………………………….…...….            4.0
The bank is subject to an income tax rate of 25%.

Required:
1. Assume that the bank will issue all of the preferred shares proposed in the prospectus. What amount of additional income must the bank earn in order to service the preferred shares without diminishing the amount of earnings currently available to the common shareholders?
2. How would your answer to 1 be different if the bank could issue bonds with an interest rate equal to 1.5% less than the prime rate?
3. Are the preferred shares attractive to investors? Explain.