Chapter 13, Problem 5BP

1.

To determine

Indicate the market value of common stock of Company S.

Explanation of Solution

Market value: Market value is the price at which, both seller and buyer agree to exchange the security. So, market value is the selling price to the seller and the purchase price for the buyer.

The market value of common stock of Company S is $90.

2.

To determine

Indicate the par values of common stock and preferred stock of Company S.

Explanation of Solution

Par value: The corporation charter assigns and allocates the dollar value for its share which is referred to as par value.

The par value of preferred stock of Company S is $\left(\frac{\text{375,000 preferred stock}}{\text{1,500 preferred shares}}\right)$$250.

The par value of common stock of Company S is $\left(\frac{\text{900,000 common stock}}{\text{18,000 outstanding common shares}}\right)$$50.

3.

To determine

Compute the book value per share of Company S’s preferred stock and common stock, if no dividends are in arrears.

Explanation of Solution

Book value per share: This is a financial ratio which measures the value of shareholders’ equity available per common share.

Formula for book value per common share:

Compute the book value per share of preferred stock of Company S.

Particulars	Amount ($)
Preferred stock value	$375,000
Number of outstanding preferred shares	÷  1,500
Book value per preferred share	$250

Table (1)

Compute the book value per share of common stock of Company S.

Particulars	Amount ($)	Amount ($)
Total stockholders’ equity	$2,400,000
Less: Equity applicable to preferred shares	375,000
Equity applicable to common shares		$2,025,000
Divide: Number of outstanding common shares		÷  18,000
Book value per common share		$112.50

Table (2)

Conclusion

Thus, the book value per share of Company S’s preferred stock and common stock is $250 and $112.50 respectively, if no dividends are in arrears.

4.

To determine

Compute the book value per share of Company S’s preferred stock and common stock, if two year preferred dividends are in arrears.

Explanation of Solution

Compute the book value per share of preferred stock of Company S.

Particulars	Amount ($)	Amount ($)
Preferred stock par value	$  375,000
Add: Two years’ dividends in arrears	$60,000
Preferred equity		$  435,000
Divide: Number of outstanding preferred shares		÷  1,500
Book value per preferred share		$290.00

Table (3)

Compute the book value per share of common stock of Company S.

Particulars	Amount ($)	Amount ($)
Total stockholders’ equity	$2,400,000
Less: Equity applicable to preferred shares	375,000
Less: Preferred dividend (1)	60,000
Equity applicable to common shares		$1,965,000
Number of outstanding common shares		÷  18,000
Book value per common share		$109.17

Table (4)

Working Note:

Compute the amount of preferred dividends for 2 years.

$\begin{array}{c}\text{Preferred dividends}=\left\{\begin{array}{l}\text{Preferred stock value}\times \\ \text{Preferred dividend percentage}\times \\ \text{2 years}\end{array}\right\}\\ =\$375\text{,000×8\%}\times \text{2 years}\\ \text{=\$60,000}\end{array}$ (1)

Conclusion

Thus, the book value per share of Corporation’s preferred stock and common stock is $290 and $109.17 respectively, if two year preferred dividends are in arrears.

5.

To determine

Compute the book value per share of Company S’s preferred stock and common stock, if two year preferred dividends are in arrears and the preferred stock is callable at $280 per share.

Explanation of Solution

Compute the book value per share of preferred stock of Corporation R.

Particulars	Amount ($)	Amount ($)
Preferred stock call price $\left(1\text{,500 shares}\times \text{\$280}\right)$	$420,000
Add: Two years’ dividends in arrears (2)	$60,000
Preferred equity		$ 480,000
Divide: Number of outstanding preferred shares		÷  1,500
Book value per preferred share		$320.00

Table (5)

Compute the book value per share of common stock of Corporation R.

Particulars	Amount ($)	Amount ($)
Total stockholders’ equity	$2,400,000
Less: Equity applicable to preferred shares	($480,000)
Equity applicable to common shares		$1,920,000
Divide: Number of outstanding common shares		÷  18,000
Book value per common share		$106.67

Table (6)

Working Note:

Compute the amount of preferred dividends for 2 years.

$\begin{array}{c}\text{Preferred dividends}=\left\{\begin{array}{l}\text{Preferred stock value}\times \\ \text{Preferred dividend percentage}\times \\ \text{2 years}\end{array}\right\}\\ =\$375\text{,000×8\%}\times \text{2 years}\\ \text{=\$60,000}\end{array}$ (2)

Conclusion

Thus, the book value per share of Company S’s preferred stock and common stock $320 and $106.67 respectively, if two year preferred dividends are in arrears and the preferred stock is callable at $280 per shares.

6.

To determine

Compute the total amount of dividend paid to the preferred and common stockholders, and dividend per share of common stock, if 2 years preferred dividends are in arrears and company declares cash dividend of $100,000.

Explanation of Solution

Common stock: Common stock is the cash raised by the company by issuing common or ordinary shares to the stockholders. This is an investment for the shareholders for which they receive the dividends from the issuing company, and have voting rights.

Preferred stock: Preferred stock is the cash raised by the company by issuing preferred shares. This investment fetches a preferential right for dividend for the preferred stockholders over the common stockholders.

Cash dividends: This is the amount of cash distributed to stockholders by a company out its earnings, according to their proportion of shares invested in the company.

Compute the dividend per share of common stock.

Particulars	Amount ($)
Cumulative preferred dividend of current year $\left(\$375,000\times 8\%\right)$	$30,000
Two year dividend in arrears (1)	60,000
Total cumulative preferred dividend paid	$90,000
Total dividends declared	$100,000
Less: Cumulative preferred dividend paid	(90,000)
Common dividend paid	$10,000
Number of common outstanding shares	÷   18,000 shares
Common dividend per share	$0.56

Table (7)

Note: Refer to Equation (1) for the value and computation of preferred dividend for two years.

Conclusion

Thus, the total amount of dividend paid to the preferred and common stockholders is $90,000 and $10,000 respectively, and the dividend per share of common stock is $0.56.

7.

To determine

Explain the reasons for which the book value not being a good estimate of its market value of the common stock.

Explanation of Solution

Reasons: The main reason for book value not being a good estimate for market price is the recording of assets at historical cost, but not the current selling price. So, book value and market value are different. Book value depends on the past transactions but current market value depends on company’s growth, earnings, market interest rate, and government policies.