Problem for Stockholders Equity in a Balance Sheet. Early in 2006, Septa Inc, wa

Question

Problem for Stockholders Equity in a Balance Sheet.

Early in 2006, Septa Inc, was organized with authorization to issue 1,000 shares of $100 par value preferred stock and 200,000 shares of $1 par value common stock. Five hundred shares of the preferred stock were issued at par, and 80,000 shares of common stock were sold at $15 per share. The preferred stock pays a 10% cumulative dividend.

During the first four years of operations (2006-2009), the corporation earned a total of $1,800,000 and paid dividends of 40 cents per share in each year on its outstanding common stock.

A. Prepare the stockholders equity section of the balance sheet at December 31, 2009. Include a supporting schedule showing your computation of the amount of retained earnings reported. (Hint: Income increased retained earnings, whereas dividends decrease retained earnings).

B. Are there any dividends in arrears onthe company's preferred stock at December 31, 2009? Explain.

C. Assume that interest rates increase steadily from 2006 - 2009. Would you expect the market price of the company's preferred stock to be higher or lower than its call price of $110 at December 21, 2009? (The call price is the amount the cmopany must pay to repurchase the shares from the stockholders)

Explanation / Answer

A.

B. No, dividends are in arrears on the company's preferred stock at December 31, 2009. This is because the company has paid Common stock Dividend in all the four years and whenever the company pays the Common stock dividend it has to pay the Preferred dividend in that year.

C. Market price will be lower than the call price because the investor will require more return and the prices will fall.

Shareholders' Equity Preferred Stock $100,000 Common Stock $80,000 Additional paid-in capital-common stock $1,120,000 Retained Earnings $1,632,000 Stockholders' Equity $2,932,000 Retained Earnings Net Income $1,800,000 Less: Dividend Preferred -$40,000 Common -$128,000 Retained Earnings $1,632,000

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