Chapter 11: Q5PSB (page 527)

Question: Soltech Company’s common stock is currently selling on a stock exchange at $90 per share, and its current balance sheet shows the following stockholders’ equity section.
Preferred stock—8% cumulative, $_ par value, 1,500 shares authorized, issued, and outstanding
$ 375,000
Common stock—$_ par value, 18,000 shares authorized, issued, and outstanding
900,000
Retained earnings
1,125,000
Total stockholders’ equity
2,400,000
Required
What is the current market value (price) of this corporation’s common stock?
What are the par values of the corporation’s preferred stock and its common stock?
If no dividends are in arrears, what is the book value per share of common stock? (Round per share value to the nearest cent.)
If two years’ preferred dividends are in arrears, what is the book value per share of common stock? (Round per share value to the nearest cent.)
If two years’ preferred dividends are in arrears and the board of directors declares cash dividends of $100,000, what total amount will be paid to the preferred and to the common shareholders? What is the amount of dividends per share for the common stock? (Round per share value to the nearest cent.)
Analysis Component
6.Discuss why the book value of common stock is not always a good estimate of its market value.

Short Answer

Expert verified

Answer

$1,620,000
Par value of common and preferred stock is $50 and $250.
Book value of common stock $112.50
Book value of common stock when preference dividend in arrear is $109.17.
Dividend Amount paid to common and preferred stock holders are $90,000 and $10,000 respectively. Dividend per share of common stock is $0.56.
Book value of common stock is not good estimate for market value as it depends on historical value while market value depends on future earnings and growth.

Step by step solution

(1) Computing market value of common stock

$M a r k e t V a l u e o f C o m m o n S t o c k = N u m b e r o f C o m m o n S t o c k \times C u r r e n t P r i c e = 18, 000 \times $ 90 = $ 1, 620, 000$

The market value of the corporation’s common stock is $1,620,000.

(2) Computing par value of preferred stock and common stock

Par value of the common stock: -

$P a r V a l u e o f C o m m o n S t o c k = \frac{T o t a l C o m m o n S t o c k V a l u e}{N u m b e r o f C o m m o n S t o c k} = \frac{$ 900, 000}{18, 000} = $ 50$

Par value of the preferred stock: -

$P a r V a l u e o f P r e f e r r e d S t o c k = \frac{T o t a l V a l u e o f P r e f e r r e d S t o c k}{N u m b e r o f P r e f e r r e d S t o c k} = \frac{$ 375, 000}{1, 500} = $ 250$

(3) Computing the book value per share of common stock

$B o o k V a l u e o f C o m m o n S t o c k = \frac{T o t a l S t o c k h o l d e r s' e q u i t y - T o t a l P r e f e r r e d S t o c k}{N u m b e r o f C o m m o n S t o c k} = \frac{$ 2, 400, 000 - $ 375, 000}{18, 000} = $ 112.50$

The book value of common stock is $112.5

(4) Computing the book value per share of common stock

$A r r e a r o f P r e f e r r e d D i v i d e n d = T o t a l P r e f e r r e d S t o c k \times I n t e r e s t R a t e \times N u m b e r o f Y e a r s = $ 375, 000 \times 8 % \times 2 = $ 60, 000 B o o k V a l u e o f C o m m o n S t o c k = \frac{T o t a l S t o c k h o l d e r s' e q u i t y - (\ b e g i n g a t h e r e d T o t a l P r e f e r r e d S t o c k \ h f i l l + A r r e a r P r e f e r e n c e D i v i d e n d \ h f i l l \ e n d g a t h e r e d)}{N u m b e r o f C o m m o n S t o c k} = \frac{$ 2, 400, 000 - ($ 375, 000 + $ 60, 000)}{18, 000} = $ 109.17$

(5)(a) Computing total amount will be paid to the preferred and the common shareholders

Amount of preferred dividends: -

$T o t a l C a s h D i v i d e n d = P r e f e r r e d D i v i d e n d + C o m m o n D i v i d e n d$

The amount of the preferred dividend is $90,000.

Amount of common dividend: -

$A m o u n t o f P r e f e r r e d D i v i d e n d = T o t a l P r e f e r r e d S t o c k \times I n t e r e s t R a t e \times N u m b e r o f Y e a r s = $ 375, 000 \times 8 % \times 3 = $ 90, 000$

The amount of the common dividend is $10,000.

$A m o u n t o f C o m m o n D i v i d e n d = T o t a l C a s h D i v i d e n d - A m o u n t o f P r e f e r r e d D i v i d e n d = $ 100, 000 - $ 90, 000 = $ 10, 000$

(5)(b) Computing dividend per share of common stock

$D i v i d e n d P e r S h a r e o f C o m m o n S t o c k = \frac{A m o u n t o f C o m m o n D i v i d e n d}{N u m b e r o f O u t s t a n d i n g S h a r e s} = \frac{$ 10, 000}{18, 000} = 0.56$

Reason why book value of common stock is not good estimate of for market value:

Market value of stock is function of future earnings growth, dividend, industry and economic factors while the book value of common stock is depend upon the historical value of assets and liabilities therefore book value of common stock is not good estimate of for market value

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1. Owner authority and control	a. Requires government approval
2. Ease of formation	b. Corporate income is taxed
3. Transferability of ownership	c. Separate legal entity
4. Ability to raise large capital amounts	d. Readily transferred
5. Duration of life	e. One vote per share
6. Owner liability	f. High ability
7. Legal status	g. Unlimited
8. Tax status of income	h. Limited

Short Answer

Step by step solution

(1) Computing market value of common stock

(2) Computing par value of preferred stock and common stock

(3) Computing the book value per share of common stock

(4) Computing the book value per share of common stock

(5)(a) Computing total amount will be paid to the preferred and the common shareholders

(5)(b) Computing dividend per share of common stock

Reason why book value of common stock is not good estimate of for market value:

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Preferred stock—8% cumulative, \)___ par value, 1,500 shares authorized, issued, and outstanding	\( 375,000
Common stock—\)___ par value, 18,000 shares authorized, issued, and outstanding	900,000
Retained earnings	1,125,000
Total stockholders’ equity	2,400,000