Razz Corporation’s common stock is currently selling on a stock exchange at $170
ID: 2356206 • Letter: R
Question
Razz Corporation’s common stock is currently selling on a stock exchange at $170 per share, and its current balance sheet shows the following stockholders’ equity section:Preferred stock, 5% cumulative $___ par value, 1000 shares
authorized, issued, and outstanding $ 100,000
Common stock, $___ par value, 4,000 shares authorized, issued,
and outstanding 160,000
Retained earnings 300,000
Total stockholders’ equity $560,000
Required
1. What is the current market value (price) of this corporation’s common stock?
2. What are the par values of the corporation’s preferred stock and its common stock?
3. If no dividends are in arrears, what are the book values per share of the preferred stock and the common stock?
4. If two years’ preferred dividends are in arrears, what are the book values per share of the preferred stock and the common stock?
5. If two years’ preferred dividends are in arrears and the preferred stock is callable at $110 per share, what are the book values per share of the preferred stock and the common stock?
6. If two years’ preferred dividends are in arrears and the board of directors declares cash dividends of $20,000 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?
7. What are some factors that can contribute to a difference between the book value of common stock and its market value (price)?
Explanation / Answer
Preferred stock, 5% cumulative $___ par value, 1000 shares authorized, issued, and outstanding $ 100,000. SO Par value is $100,000/1000 = $100 Common stock, $___ par value, 4,000 shares authorized, issued, and outstanding 160,000. SO Par value is $160,000/4000 = $40 Retained earnings 300,000 Total stockholders’ equity $560,000 1. What is the current market value (price) of this corporation’s common stock? A: Current Mkt price of Common stock is $170 per share. SO Common stock value is = No of shares issued * Curet price = 4000*$170 = $680,000 2. What are the par values of the corporation’s preferred stock and its common stock? As calculates above, Par Value of Pref Stock is $100 and of Common stock is $40 3. If no dividends are in arrears, what are the book values per share of the preferred stock and the common stock? The call price of the preferred stock is 5%*$100 + $100 = $105 (ie $100 Face value + 5% Pref DIvidend). SO total BV of Pref Stock = No of Pref Stock*Call price =1000*$105=$105,000 When a corporation has both common stock and preferred stock, the book value of the preferred stock is subtracted from the corporation's total stockholders' equity to arrive at the total book value of the common stock. Using the information above, we have: Corporation's total stockholders' equity $ 560,000 Less: Preferred stock's total book value –$105,000 Common stock's total book value $ 455,000 Number of shares of common stock outstanding 4,000 shares Common stock's book value per share $455,000/4000 = $114 4. If two years’ preferred dividends are in arrears, what are the book values per share of the preferred stock and the common stock? The call price of the preferred stock is $105. It is cumulative preferred and two years of dividends are owed. The book value per share of the preferred stock equals the call price of $105 plus two years of dividends at $5 each, or $115 ($105 + $10 = $115). The total book value for all of the preferred stock equals the book value per share of preferred stock times the number of shares of preferred stock outstanding, or $115,000 ($115 X 1000 = $115,000). Common Stock's Book Value When a corporation has both common stock and preferred stock, the book value of the preferred stock is subtracted from the corporation's total stockholders' equity to arrive at the total book value of the common stock. Using the information above, we have: Corporation's total stockholders' equity $ 560,000 Less: Preferred stock's total book value –$115,000 Common stock's total book value $ 445,000 Number of shares of common stock outstanding 4,000 shares Common stock's book value per share $445000/4000 = $111 5. If two years’ preferred dividends are in arrears and the preferred stock is callable at $110 per share, what are the book values per share of the preferred stock and the common stock? The total book value for all of the preferred stock equals the book value per share of preferred stock times the number of shares of preferred stock outstanding, or $110,000 ($110 X 1000 = $110,000). Common Stock's Book Value When a corporation has both common stock and preferred stock, the book value of the preferred stock is subtracted from the corporation's total stockholders' equity to arrive at the total book value of the common stock. Using the information above, we have: Corporation's total stockholders' equity $ 560,000 Less: Preferred stock's total book value –$110,000 Common stock's total book value $ 450,000 Number of shares of common stock outstanding 4,000 shares Common stock's book value per share $450000/4000 = $113 6. If two years’ preferred dividends are in arrears and the board of directors declares cash dividends of $20,000 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? The basic rule is that preferred stockholders receive up to the specified dividend first, with the remaining amount (if any) being given to common stockholders. Yearly Pref div is $5*1000 = $5000. So for 3 yrs (ie 2 Yrs arrear+ current Yr), Pref div is 3*$5000 = $15000. So Common Stokc holder will get only $20000-$15000=$5000 in Dividend Div per share for COmmon stock holder = DIv amt/No of common shares = $5000/4000=$1.25 per share 7. What are some factors that can contribute to a difference between the book value of common stock and its market value (price)? Book value has two serious issues: 1 - the book value may not reflect the actual resale value of the company's assets: If a company has a widget factory that cost $10 million to build, financed in part by a $5 million loan, then the company's book value would be 10 - 5 = $5 million. However would the company actually be able to sell its widget factory for $10 million? That depends completely on whether or not a buyer felt that the widgets were worth making. What if these widgets were typewriters. How valuable would a factory that made typewriters be in an age of modern computers? Naturally in this case the market value of this particular company's shares would probably be below "book value" because a factory that makes typewriters is pretty much useless and would have very little resale value despite what it says on paper. 2 - the company's future cash flows are more valuable than its book value. This is very common. Imagine you owned a real estate business. Assume that this business has a $1 million building (market value), financed with a $900,000 mortgage. If you sold the building you would be left with $100,000 in equity :) However imagine that the building would produce $50,000 per year in rent revenue for at least 30 years. Now what would you rather do? You could sell the business and have a one-time lump sum of $100,000 now? Or keep the business and receive 30 payments of $50,000 each over the next 30 years? This is why the market value of a business is often higher than its book value.
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