Chapter 11, Problem 5PSA

To determine

Preferred Stock:

Preferred stock is a sort of stockholder‘s capital which has special right as comparison to equity to shareholder, like fixed dividend and preferential treatment in event of liquidation and payment of dividend.

Common Stock:

It shows the total amount of money that the owner has in this business. Owner use their right of being owner by voting for important matters in the general meetings of the company.

Dividends:

It is the amount of profit that is distributed among shareholders of the company. It can be distributed in two ways, one is cash dividend and other is stock dividend.

Market Value per Share:

It is the value of the share of the company in the market or in the stock exchange in which the company is listed.

(1)

To compute:

Market value of share.

Explanation of Solution

Market value of share

Formula for market value of share:

$\text{Market}\text{value}\text{of}\text{common}\text{stock}=\left(\begin{array}{l}\text{Total}\text{number}\text{of}\text{shares}\\ \times \text{Market}\text{price}\text{of}\text{share}\end{array}\right)$

Given,

Total number of shares is 4,000.

Market price of share is $85.

Substitute, 4,000 for total number of shares and $85 for market price of share in the above formula,

$\begin{array}{c}\text{Market}\text{Value}\text{of}\text{Common}\text{Stock}=4,000\times \$85\\ =\$340,000\end{array}$

Hence, the market value of common stock is $340,000.

To determine

(2)

To compute:

Par value of common stock and preferred stock.

Explanation of Solution

Par value of share

Formula for par value of stock:

$\text{Par}\text{value}\text{of}\text{stock}=\frac{\text{Stock}}{\text{Number}\text{of}\text{outstanding}\text{shares}}$

Common stock:

Given,

Common stock is $80,000.

Number of outstanding shares is 4,000.

Substitute, $80,000 for common stock and 4,000 for number of outstanding shares in the above formula,

$\begin{array}{c}\text{Par}\text{value}\text{of}\text{common}\text{stock}=\frac{\$80,000}{4,000}\\ =\$20\end{array}$

Hence, the par value of common stock is $20.

Preferred stock:

Given,

Preferred stock is $50,000.

Number of outstanding shares is 1,000.

Substitute, $80,000 for preferred stock and 1,000 for number of outstanding shares in the above formula,

$\begin{array}{c}\text{Par}\text{value}\text{of}\text{preferred}\text{stock}=\frac{\$50,000}{1,000}\\ =\$50\end{array}$

Hence, the par value of preferred stock is $50.

To determine

(3)

To compute:

Book value of common stock with no arrears.

Explanation of Solution

Book value:

Formula for book value of common stock:

$\text{Book}\text{value}\text{per}\text{share}=\frac{\text{Stockholders'}\text{equity}-\text{Preferred}\text{stock}}{\text{Number}\text{of}\text{common}\text{shares}}$

Given,

Stockholder‘s equity is $280,000.

Preferred stock is $50,000.

Number of common shares is 4,000.

Substitute, $280,000 for stockholder‘s equity,$50,000 for preferred stock and 4,000 for number of common share in the above formula,

$\begin{array}{c}\text{Book}\text{value}\text{par}\text{share}=\frac{\$280,000-\$50,000}{4,000}\\ =\$57.50\end{array}$

Hence, the market value of common stock is $57.50.

To determine

(4)

To compute:

Book value of common stock with arrears.

Explanation of Solution

Book value:

Formula for book value of common stock:

$\text{Book}\text{value}\text{per}\text{share}=\frac{\text{Stockholders'}\text{equity}-\text{Preferred}\text{stock}}{\text{Number}\text{of}\text{common}\text{shares}}$

Given,

Stockholder‘s equity is $275,000.

Preferred stock is $50,000.

Number of common shares is 4,000.

Substitute, $275,000 for stockholder‘s equity,$50,000 for preferred stock and 4,000 for number of common share in the above formula,

$\begin{array}{c}\text{Book}\text{value}\text{par}\text{share}=\frac{\$275,000-\$50,000}{4,000}\\ =\$56.25\end{array}$

Hence, the market value of common stock is $56.25.

Working Notes:

Calculation for stockholder‘s equity:

$\begin{array}{c}\text{Total}\text{stockholder's}\text{equity}=\text{Stockholder's}\text{equity}-\text{Preferred}\text{dividend}\\ =\$280,000-\$5,000\\ =\$275,000\end{array}$

$\begin{array}{c}\text{Preferred}\text{dividend}=\text{Preferred}\text{stock}\times \text{Rate}\text{of}\text{interest}\times \text{Number}\text{of}\text{years}\\ =\$50,000\times \frac{5}{100}\times 2\\ =\$5,000\end{array}$

To determine

(5)

To compute:

Dividend paid to preferred and common shareholders and dividend per share for common stock.

Explanation of Solution

Preferred dividend:

Formula for preferred dividend:

$\text{Preferred}\text{dividend}=\text{Preferred}\text{stock}\times \text{Rate}\text{of}\text{interest}\times \text{Number}\text{of}\text{years}$

Given,

Preferred stock is $50,000.

Rate of interest is 5%.

Number of years is 3.

Substitute, $50,000 for preferred stock, 5% for rate of interest and 4 for number of years in the above formula,

$\begin{array}{c}\text{Preferred}\text{dividend}=\$50,000\times \frac{5}{100}\times 3\\ =\$7,500\end{array}$

Hence, the preferred dividend is $7,500.

Formula for common stock dividend:

$\text{Common}\text{Stock}\text{dividend}=\text{Total}\text{dividend}-\text{Preferred}\text{dividend}$

Given,

Preferred dividend is $7,500.

Total dividend is $11,500.

Substitute, $7,500 for preferred dividend and $11,500 for total dividend in the above formula,

$\begin{array}{c}\text{Common}\text{stock}\text{dividend}=\$11,500-\$7,500\\ =\$4,000\end{array}$

Hence, the common stock dividend is $4,000.

Formula for dividend per share:

$\text{Dividend}\text{per}\text{share}=\frac{\text{Total}\text{dividend}}{\text{Number}\text{of}\text{outstanding}\text{shares}}$

Given,

Total dividend is $4,000.

Number of outstanding shares is 4,000.

Substitute, $4,000 for total dividend and 4,000 for number of outstanding shares in the above formula,

$\begin{array}{c}\text{Dividend}\text{per}\text{share}=\frac{\$4,000}{4,000}\\ =\$1\end{array}$

Hence, the market value of common stock is $1.

To determine

(6)

To explain:

Reasons that contribute to difference between market and book value of share.

Explanation of Solution

Reasons for the difference between market and book value are:

• Assets and liabilities are recorded at historical cost and not on market value.
• Book value show the price of share according to the books of the company but market value is determined by the demand or supply of that particular stock.

Hence, the reason is demand and supply and historical concept followed for accounting.