Mb101 Accounting (New)

MB101 AccountingTutorial 4: Question 4

Tan Ti FenCui Dong YaoLim Ming HuiMelissa Tan

Tutorial 4 : Question 4

Preferred stock – 5% cumulative

1,000 shares issued and outstanding $50,000

Common stock

4,000 shares issued and outstanding $80, 000

Retained earnings $150,000

Total stockholder’s equity $280,000

Rachael Corporation’s common stock is currently selling on stock exchange at $85 per share, and its current balance sheet shows

the following stockholders’ equity section

Lecture 4: Stockholders’ Equlity [Preferred and Common Stock]

Common Stock

Preferred Stock

Voting rights

Priority over liquidation

Obligation to pay dividends

Lecture 4: Stockholders’ Equlity [Differences between Common stock and Preferred stock stock] Common stock vs

Preferred Stock

YES NO

YES

YES

NO

NO

Question (4a) What is the current market value of this corporation’s

common stock?

Lecture 4: Stockholders’ Equlity [Market value and Issue value]

Preferred stock – 5% cumulative 1,000 shares issued and outstanding

$50,000

Common stock

4,000 shares issued and outstanding

$80, 000

Retained earnings $150,000

Total stockholder’s equity $280,000

Rachael Corporation’s common stock is currently selling on stock exchange at $85 per share, and its current balance sheet shows

the following stockholders’ equity section

Lecture 4: Stockholders’ Equity [Quick Refresh ! ]

• Price shown are issue price of stock

to shareholders.

• Market Values do not appear in the

equity sheet of the corporation!

Looking at the question again…..

Question (4a) What is the current market value of this corporation’s

common stock?Answer: $85 x 4000 = $340 000

Lecture 4: Stockholders’ Equlity [Market Value]

Question (4b) If no dividend are in arrears, what is the book value per

share of common stock?

Lecture 4: Stockholders’ Equlity [Calculating Book value]

4b) If no dividend are in arrears, what is the book value per share of common

stock?• No dividend are in arrears?– No unpaid dividend on cumulative preferred shares. – If there is any unpaid dividend, it must be paid

before paying any current dividends on the preferred shares and common shares.

Lecture 4: Stockholders’ Equlity [Calculating Book value: Quick Refresh!]

Lecture 4: Stockholders’ Equity [Calculating Book value: Quick Refresh!]

THE FORMULA :

Deriving Total stockholders equity: Inclusive of : Common StockInclusive of :Preferred Stock and Preferred dividends in arrears) Inclusive of: Retained Earnings

4b) If no dividend are in arrears, what is the book

value per share of common stock?

Total book value of common stock= (total stockholders’ equity) - (preferred stock)= $280,000 - $50,000= $230,000

Book value per share of common stock= (total book value of common stock) / (no. of shares issued and

outstanding)= $230,000 / 4,000= $ 57.50

If no dividend are in arrears, what is the book value per share of common stock?

Answer:

Lecture 4: Stockholders’ Equlity [Calculating Book value: Answer for 1b]

Question (4C) c) If 2 years’ preferred dividend are in arrears, what is the book value per share of common

stock?

Lecture 4: Stockholders’ Equlity [Calculating book value per share with

Cumulative preferred dividend]

2 years’ preferred dividend are in arrears….• Since there is unpaid dividend on cumulative preferred

stock

• The total amount owed to preferred stockholders must be paid first.

• Not to forget current year preferred dividends to be paid first too.

4c) If 2 years’ preferred dividend are in arrears, what is the book value per share of common stock?



c) If 2 years’ preferred dividend are in arrears, what is the book value per share of common stock?Answer: Total amount of 2 years’ preferred dividend in arrears= (3 years)(Percentage of preferred dividend x preferred stock) = (3)( 5% x $50,000)= $7,500Total book value of common stock= (Total stockholders’ equity)- (Preferred stock)- (2 years’

Preferred dividend in arrears)= $280,000 - $50,000 - $7,500= $222,500



Book value per share of common stock= (Total book value of common stock)/ (No. of shares

issued and outstanding)= $222,500 / 4,000= $ 55.63 (nearest cent)

This calculation procedure reflects the fact that the common stockholders are the

residual owners of the corporate entity.

Continue….c) If 2 years’ preferred dividend are in arrears, what is the book value per share of common stock?Answer:



4d) Part 1) If two years’ preferred dividends are in arrears and the board of directors declares cash dividends of $11,500, what total amount will be

paid to the preferred and to the common shareholders?

Step 1: Preferred dividends in arrears (must pay, 5% cumulative)

Step 2: Current year preferred dividends (paid before common dividends)

Step 3: Current year common dividends

Lecture 4: Stockholders’ Equlity [Allocation of Dividends between Preferred

and Common stock]

Answering this question in 3 steps:

Cash Dividends of

$11,500

Step 1: Preferred dividends in arrears (must pay, 5% cumulative)

• Total amount of preferred stock: $50,000• Dividend rate: 5%• Time: 2 years Preferred dividend= Principal x dividend rate x time• Total amount of preferred dividends in arrears:

$50,000 x 5% x 2=$5000


and Common stock]

Step 2: Current year preferred dividends (paid before common dividends)

• Total amount of preferred stock: $50,000• Dividend rate: 5%• Time: 1 year

• Current year amount of preferred dividends:$50,000 x 5% x 1=$2500

• Total amount of preferred dividends:

$5000 + $2500=$7500

Lecture 4: Stockholders’ Equity [Allocation of Dividends between Preferred

and Common stock]

Step 3: Current year common dividends

Deriving Common stock dividends:

Total Cash dividends - 3years of Cumulative Preferred dividends = Common dividends.

$11,500-$5000-$2500=$4000


and Common stock]

• Amount of dividends per share = Total amount of common dividends Shares of common dividends

= $4000/4000

=$1

4d)Part 2)What is the amount of dividends per share for the

common stock?


and Common stock]

Question (4e) Identify two reasons a corporation may

choose to issue cumulative preferred stock rather than finance operation with long

term debt.

Lecture 4: Stockholders’ Equity [Debt and Equity financing]

1. Has a maturity date

2. Creditors of the business

3. If business ceases, creditors must be

paid in full

4. Usually requires borrower to pay

interest

1. No maturity date

2. Owners of the business

3. If business ceases, stockholders might

not get the full capital back

4. Might receive dividend.

Lecture 4: Stockholders’ Equity [Debt and Equity financing: Quick Refresh!]

Debt vs Equity

Answer: • Long term liabilities comes with heavy burden Obligation to pay up principle amount by maturity date.- Unlike equity, debt must at some point be repaid. Regular debt’s Interest Rate Vs Dividends

• Restrict the growth of the company Larger a company’s debt-equity ratio (highly leveraged), they are consider

more risky by lenders and investors. - Lenders Less willing to loan funds to finance the company- Investors Less confident to invest funds in the company- In long term, capital to finance the company is lower. High cost of servicing the debts, might end up restricting the growth of the

company instead.

Lecture 4: Stockholders’ Equity [Debt and Equity financing]

Q & A !

Economy & Finance

Mb101 Accounting (New)