Early last year, you invested $400,000 in cash in the common stock of 3M and Zeb
ID: 2460490 • Letter: E
Question
Early last year, you invested $400,000 in cash in the common stock of 3M and Zebra Technologies. During the first year that these securities were held, 3M paid dividends of $1.92 per share and Zebra paid no dividends. At December 31 of last year, the following values were reported for these investments:
COST MARKET
3M (2,000 shares: cost, $100 per share; market value $80 per share) $200,000 160,000
Zebra Tech. (10,000 shares: cost $20 per share; market $24 per share) $200,000 240,000
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Early in the current year, you sold 500 shares of 3M and 1,000 shares of Zebra “at the market”. Ten minutes later your stock broker reported to you that both transactions had been executed. Total sales proceeds for you were $42,500 for the 3M shares and $23,000 for the Zebra shares.
Instructions:
a. Separately compute your unreal gain/loss in each of these investments as of December 31 of last year (above dotted line). Indicate the total unrealized gain/loss that will appear in last year’s financial statements and make the mark to market adjustment.
b. Prepare two separate journal entries to record the sale of the 3M shares and Zebra shares early in the current year.
c. Briefly comment about the liquidity, risk, and potential return of investments in common stocks relative to, say, cash equivalents that are very safe and yield a “sure” return of say 4%. Cite data from this problem in support of your comments.
d. How much real money did you make/lose on each of these two stocks?
Explanation / Answer
Answer 1
In case of 3M
No. of shares
2000
Cost per share
$100
Total Cost (A)
$200,000
Market value per share
$80
Total Market value (B)
$160,000
Unrelaized loss (A)-(B)
$40,000
In case of Zebra Technologies
No. of shares
10000
Cost per share
$20
Total Cost (A)
$200,000
Market value per share
$24
Total Market value (B)
$240,000
Unrelaized gain (B)-(A)
$40,000
Answer 2
Journal Entries
In case of 3M
Particulars
Dr. (Amount in $)
Cr. (Amount in $)
Cash A/c
42,500
Investment A/c
40,000
Gain on sale of Investment
2,500
In case of Zehra
Particulars
Dr. (Amount in $)
Cr. (Amount in $)
Cash A/c
23000
Loss on sale of Investment
1000
Investment A/c
24000
Answer 3
Liquidity
Liquidity means trading of securities without losing its value.
Greater the difference between the price that the buyer is willing to pay and the price seller is asking, market is illiquid and vice versa
In case 1, seller has realized more than market value i.e. 42500-40000=2500, assets/ shares are liquid assets
In case 2, seller has realized less than market value i.e. 24000-23000=1000, assets/ shares are illiquid assets
Risk
Risk is of two types i.e. Unsystematic risk and Systematic risk
Unsystematic risk: Unsystematic risk is diversifiable and can be reduced by owning the different type of securies or owning of securities in more than one company.
Systematic risk: It is undiversifiable and impossible to avoid
Potential return of investment
Investment in 3M: It declared dividend. Its market value is less than cost but it made profits in case of sale of shares.
Investment in Zebra: It has not declared dividend but its market value is more than cost. It made losses in case of sale of shares.
Answer 4
In case of 3M
Particulars
Amount (in $)
Total Cost
50,000
Selling prize
42,500
Dividend received
960
Money lost
6,540
In case of Zehra
Particulars
Amount (in $)
Total Cost (1000*20)
20,000
Selling prize
23,000
Dividend received
-
Money gain
3,000
Answer 1
In case of 3M
No. of shares
2000
Cost per share
$100
Total Cost (A)
$200,000
Market value per share
$80
Total Market value (B)
$160,000
Unrelaized loss (A)-(B)
$40,000
In case of Zebra Technologies
No. of shares
10000
Cost per share
$20
Total Cost (A)
$200,000
Market value per share
$24
Total Market value (B)
$240,000
Unrelaized gain (B)-(A)
$40,000
Answer 2
Journal Entries
In case of 3M
Particulars
Dr. (Amount in $)
Cr. (Amount in $)
Cash A/c
42,500
Investment A/c
40,000
Gain on sale of Investment
2,500
In case of Zehra
Particulars
Dr. (Amount in $)
Cr. (Amount in $)
Cash A/c
23000
Loss on sale of Investment
1000
Investment A/c
24000
Answer 3
Liquidity
Liquidity means trading of securities without losing its value.
Greater the difference between the price that the buyer is willing to pay and the price seller is asking, market is illiquid and vice versa
In case 1, seller has realized more than market value i.e. 42500-40000=2500, assets/ shares are liquid assets
In case 2, seller has realized less than market value i.e. 24000-23000=1000, assets/ shares are illiquid assets
Risk
Risk is of two types i.e. Unsystematic risk and Systematic risk
Unsystematic risk: Unsystematic risk is diversifiable and can be reduced by owning the different type of securies or owning of securities in more than one company.
Systematic risk: It is undiversifiable and impossible to avoid
Potential return of investment
Investment in 3M: It declared dividend. Its market value is less than cost but it made profits in case of sale of shares.
Investment in Zebra: It has not declared dividend but its market value is more than cost. It made losses in case of sale of shares.
Answer 4
In case of 3M
Particulars
Amount (in $)
Total Cost
50,000
Selling prize
42,500
Dividend received
960
Money lost
6,540
In case of Zehra
Particulars
Amount (in $)
Total Cost (1000*20)
20,000
Selling prize
23,000
Dividend received
-
Money gain
3,000
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