Professional Documents
Culture Documents
Chapter 11 Solutions Manual
Chapter 11 Solutions Manual
SHAREHOLDERS' EQUITY:
CAPITAL
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Brief Learning
Exercises Topic Objective Skills
s
B. Ex. 11.1 Shareholders' equity 4 Analysis
B. Ex. 11.2 Shareholders' equity 4 Analysis
B. Ex. 11.3 Dividends on preference shares 5 Analysis, communication
B. Ex. 11.4 Dividends on ordinary and 5 Analysis
preference shares
B. Ex. 11.5 Dividends on ordinary and preference 5 Analysis, communication
shares
B. Ex. 11.6 Book value 7 Analysis, communication
B. Ex. 11.7 Book value 7 Analysis
B. Ex. 11.8 Share split 8 Analysis, communication
B. Ex. 11.9 Treasury shares 4, 9 Analysis
B. Ex. 11.10 Treasury shares 4, 9 Analysis
Learning
Exercises Topic Objective Skills
11.1 Form of organization s
1–3 Analysis, communication
11.2 Accounting terminology 1–9 Analysis
11.3 Prepare equity section 4, 5 Analysis, communication
11.4 Dividends on preference & ordinary 4, 5 Analysis, communication
shares
11.5 Analyzing equity 4–7 Analysis
11.6 Preference shares alternatives 5, 6 Analysis
11.7 Reporting effects of transactions 4, 7 Analysis
11.8 Computing book value 4–7 Analysis, communication
11.9 Treasury shares transactions 9 Analysis, communication
11.10 Effects of share splits 8 Communication, judgment
11.11 Treasury shares presentation 9 Communication, judgment
11.12 Real World: Star Cruises Limited 4 Analysis, communication
Below are brief descriptions of each problem and case. These descriptions are accompanied by the
estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume
use of the partially filled-in working papers.
Problems (Sets A and B)
11.1 A,B Robbinsville Press/Septa Limited 20 Easy
A short problem requiring the completion of the shareholders’
equity section of a corporate balance sheet. Includes preference
share dividends and conceptual issues pertaining to the market
price of preference shares.
1. Large corporations are often said to be publicly owned because they are literally owned by the
general public. The shares of many large corporations is actively traded on organized stock
exchanges, such as the Singapore Exchange. Anyone may purchase an ownership interest in such
corporations, even if that interest is but a single share. Many large corporations have hundreds of
thousands, even millions, of individual shareholders.
2. a. Owners’ liability for debts of the business. Sole proprietors are personally liable for the debts
of the business. A corporation, however, is responsible for its own debts; the shareholders of a
corporation are not personally liable for the debts of the business entity. Thus, the amount of
money that a shareholder might lose by investing in a corporation is limited to the amount of
his or her investment.
b. Transferability of ownership interest. A sole proprietor generally must sell his or her entire
interest in the business. This creates a new business owned by a new sole proprietor. Shares in
a corporation are freely transferable.
d. Federal taxation on income. A corporation is subject to federal income tax on its income, and
shareholders are also subject to a personal income tax on any amounts they receive as
dividends. A sole proprietorship is not a taxable entity, but the owner must pay personal taxes
on the income earned by the business, whether or not it is actually withdrawn by the owner.
3. There are three basic rights: (1) the right to vote, (2) the right to share in dividends when declared,
and (3) the right to share in assets upon liquidation.
4. The term double taxation refers to the fact that the profit of a corporation may be taxed on two
separate occasions. First, the profit of a corporation is subject to corporate income taxes, which
must be paid by the corporation. Second, if the corporation distributes its earnings as dividends to
shareholders, the shareholders must pay personal income taxes on the amounts they receive. This
double taxation of profit is one of the principal disadvantages of the corporate form of business
organization.
5. Capital of a corporation represents the amount invested by shareholders and is generally not
available for dividends. Retained earnings represents the cumulative amount of profit not
distributed to shareholders as dividends. The distinction between share capital and retained
earnings is useful because it shows how much of the total shareholders’ equity represents
investments by the owners and how much has been accumulated through profitable operations
since the company started in business.
Par value is not an indication of a fair market price for an ordinary share. The market price of
the share is determined by such factors as the profitability and solvency of the issuing company,
interest rates, the amount of dividends paid by the share, and general market conditions. The
market price of a share may be above or below its par value.
7. a. Cumulative means that unpaid dividends on preference shares are carried forward and
must be fully paid before any dividends can be paid on ordinary shares.
b. Convertible means that each preference share may be returned to the corporation in
exchange for a given number of ordinary share under specified conditions.
8. Noncumulative preference share is entitled to dividends only if and when they are declared. If
noncumulative preference dividends had not been declared for several years, it would be
possible to declare only the current year’s dividends on preference share and then declare a
dividend on ordinary shares. Noncumulative preference shares does not have the protection
afforded by the cumulative requirements that any dividends in arrears must be paid before
dividends can be paid on ordinary shares. This means a weak form of dividend preference, and
as a result the noncumulative feature is not attractive to most investors.
9. (a) Cash is classified as an asset; (b) Organization Costs typically are classified as an expense;
(c) Preference Shares, (d) Retained Earnings, and (e) Share premium are all classified as
shareholders’ equity accounts; (f) Income Taxes Payable is classified as a liability.
10. a. Share transfer agent. A bank or trust company retained by a corporation to maintain
records of share ownership and transfers.
c. Underwriter. An investment banking company that undertakes to sell new corporate shares
to investors. The underwriter usually guarantees the corporation a specified price, and
plans to make a profit by selling to individual investors at a slightly higher price.
11. Book value per share represents the amount of net assets (or shareholders’ equity) associated
with each ordinary share. It is determined by dividing the total shareholders’ equity in the
corporation, less the amount assigned to preference shares (par value, or liquidation value if
given, plus dividends in arrears) by the number of ordinary shares outstanding. Book value does
not represent the amount ordinary shareholders would receive in the event of liquidation. If a
corporation were liquidated, many assets would be sold at prices different from their carrying
values in the accounting records. The resulting gains or losses would cause shareholders’ equity
to change accordingly.
13. a. When a corporation obtains a bank loan there is no effect upon book value per ordinary share.
Assets and liabilities both increase by the amount of the loan. Net assets, therefore, are unchanged.
b. Declaration of a dividend reduces book value per share. Total assets are not affected by the
declaration of a dividend, but liabilities are increased. Net assets (shareholders’ equity), therefore,
are decreased.
14. A change in the market price of IBM’s outstanding shares has no effect upon IBM’s balance sheet.
These shares belong to IBM’s shareholders, not to IBM. Therefore, a change in the market value of
these shares has no effect upon the recorded amounts of IBM’s assets, liabilities, or shareholders’
equity. IBM’s share capital accounts will continue to show the amount received by IBM at the time
the ordinary share was issued. This historical amount is not affected by subsequent changes in market
price.
15. When you ask a sharebroker to purchase shares for you, the shares is purchased on a secondary
market—in this case the Singapore Exchange, because that is where Singapore Airlines shares are
traded. On a secondary market, you are purchasing the shares from another investor. The transaction
will have no effect on the financial statements of Singapore Airlines.
16. The purpose of a share split is to reduce the per-share market price of the company’s shares down to a
more appropriate “trading range”—that is, a price that is appealing to a greater number of potential
investors.
17. Treasury shares are corporate shares that has been issued and then reacquired by the issuing company.
One reason for acquiring treasury shares is to have shares available to issue to officers and employees
under profit-sharing agreements, shares options, or bonus plans. Purchases of treasury shares may
also be intended to support the market price of the shares or to increase earnings per share.
Treasury shares are not asset; it represents a reduction in the amount of shareholders’ investment in
the corporation. For this reason the cost of the treasury shares are reported in the balance sheet as a
reduction of the shareholders’ equity.
19. The major types of transactions and activities that change the amount of issued and fully paid capital and
the direction of that change are as follows:
20. No definitive answer can be given to this question because a case can be made for having preference
shares and for not having preference shares. Similarly, if preference shares are included in the capital
structure, a case can be made for different features, primarily whether the dividend is cumulative or not.
Following are comments under different assumptions about the desirability of preference shares.
Include preference shares—Preference shares offer investors an opportunity to invest on what may be a
more predictable and secure basis than ordinary share. While dividends are not guaranteed, they are
more predictable than on ordinary share, particularly for a new company. Some investors may be
willing to invest in preference shares while they would not be willing to accept the greater uncertainty
and risk of ordinary share. This may be a factor in designing the company’s capital structure in light of
the capital requirements of the new company.
Do not include preference shares—The presence of preference shares may make ordinary shares less
attractive in light of the dividend preference of preference shares. Once the company is up and running,
preference shares may be undesirable in terms of the long-term capital structure of the company.
Features of preference shares—Assuming preference shares are included in the capital structure, the
most important decision is whether the dividend is cumulative. If the dividend is cumulative, the
preference shares are more attractive to investors, but it detracts from the attractiveness of the ordinary
shares. The lack of the cumulative feature may make preference shares a relatively weak investment
alternative and effectively defeat the purpose of including preference shares in the capital structure.
B.Ex. 11.3 Dividends on arrears on preference shares for three years are calculated as
follows:
100,000 shares x $100 par value x 6% dividend rate x 3 years =
$1,800,000
If the preference shares is cumulative, the entire dividend goes to preference shares
and the ordinary shareholders will receive none of the $120,000 dividends
declared. In fact, satisfaction of the full claim of the preference sharesholders in
this case will require $320,000, determined as follows:
This amount does not reflect the current market value of the shares. Instead, it
reflects a per-share amount of the assets, less liabilities, included in the company's
balance sheet.
B.Ex. 11.8 The share split will double the number of shares outstanding from 100,000 to
200,000. It will reduce the market price of the shares to approximately half of its
current price: $50 x 1/2 = $25. The split will have no impact on the total
shareholders' equity attributable to ordinary shares. While the number of shares
will double, the par value will be reduced to half, or $5 per share, leaving the total
shareholders' equity attributable to ordinary shares unchanged.
Ex. 11.1 a. (1) Organizing the scuba diving school as a sole proprietorship.
Advantages:
(a) Easy to form
(b) No double taxation on distributed earnings
Disadvantages:
(a) Personal liability of owner for debts of the business
(b) Business ceases with death of owner
b. No. The market value of a corporation’s shares have no effect on the amount in the
financial statements. Share capital is recorded at the amount for which it was
originally issued.
c. The shareholders’ equity section of the balance sheet reports no share premium.
Thus, the preference shares must have been issued at their respective par values
($50 per share for the 9% noncumulative preference shares, and $100 per share for
the noncumulative preference shares).
Ex. 11.5 a. 150,000 shares ($15,000,000 total par value, divided by $100 par value per share)
f. No. Changes in the market value of shares do not directly affect a corporation’s
financial position and are not reflected in the equity section of the balance sheet.
Ex. 11.6 Annual dividends on the preference shares are $14,000 (7,000 × $25 × 8%)
c.
No. The book value per share represents the shareholders’ share of the net book
value of the corporation’s assets, not the assets’ liquidation values. The
shareholders may receive more or less than the book value per share if the
corporation is liquidated, depending primarily on the amounts at which the
corporation’s assets are sold.
c. No, a restriction on retained earnings does not affect the total amount of retained
earnings reported in the balance sheet. A restriction of retained earnings is
disclosed, but does not reduce the total amount of retained earnings of a company.
The restriction on retained earnings simply limits the amount of dividends the
corporation can pay as long as it holds treasury shares.
b. Had the shares been split 4-for-1, it would begin trading at approximately $20
per share immediately after the split ($80 ¸ 4 = $20).
Ex. 11.11 a. Companies sometimes purchase their own ordinary shares to help boost the
market price per share. This practice is not generally considered unethical,
given that information pertaining to the purchase is fully disclosed in the
company’s financial statements. Furthermore, if the company acquires a
significantly large amount of its outstanding shares, the event would be reported
in the financial press.
Ex. 11.12 a. Carnival Corporation could sell approximately 1,336 million additional
shares. This figure is determined by subtracting the number of issued shares
from the number of authorized shares 1,960 million – 624 million = 1,336
million.
b. Shareholders' Equity:
Preference shares, 6%, $100 par value, 50,000 shares authorized,
40,000 shares issued and outstanding $4,000,000
Share premium:
Preference shares 400,000
Ordinary shares 1,100,000
Total issued and fully paid capital and retained earnings $1,950,000
Calculations:
Share premium on ordinary shares:
100,000 shares x ($18 - $10) = $800,000
Share premium on treasury shares:
10,000 shares x ($23 - $20) = $30,000
Treasury shares:
15,000 shares x $20 = $300,000
b. After a 2:1 share split is distributed, the par value of the ordinary shares will be
reduced to half ($10 x 1/2 = $5) and all of the share numbers will double. The 2:1
split has no effect on the total figures for ordinary shares, share premium,
retained earnings, treasury shares, or total shareholders' equity.
a. The number of issued and fully paid up ordinary shares can be read in the note
26 to adidas' financial statements but it is not enclosed. The share capital in the
balance sheet cannot indicate the par value of the share capital. adidas in fact
issued about 209 million no-par-value bearer shares. Issued and fully paid up
shares represents the number of shares that the company has issued and bought
by its shareholders.
b. The amount of authorized share capital can be be read in the note 26 to adidas'
financial statement but it is not enclosed. adidas' authorized share capital is
about €304 million. Authorized shares or authroized share capital are the
number of shares or the amount of share capital specified in the company’s
articles of incorporation. It represents the maximum number of shares that the
company is authorized to issue by its state of incorporation.
c. €3,771 million. This amount is not how much the outstanding shares is actually
worth. The total shareholders’ equity figure represents the amount invested in
the company by owners over time, plus the amount of earnings retained in the
company. The amount reported is an historical concept that may or may not
bear a close relationship to the shares's current market value.
b. There are no dividends in arrears at December 31, 2009. We know this because ordinary
dividends were paid in each of the four years that the company was in existence. Ordinary
shareholders could not have received dividends in each year of the company’s existence had
any dividends been in arrears on the preference shares.
b. A corporation might decide to use preference shares rather than debt to finance operations
for any of the following reasons (only 2 required):
1. Dividends do not have to be paid each year and do not become a legal obligation of the
corporation until they are declared. Interest on debt is a legal obligation of the
corporation and must be paid each year.
2. Debt must be repaid at some future date. To be a permanent source of capital, debt must
be periodically refinanced. Preference shares generally does not mature.
3. Increasing the amount of debt on a balance sheet can adversely affect financial ratios.
20__
Jan 6 Cash 280,000
Ordinary Shares 40,000
Share Premium: Ordinary Shares 240,000
Issued 20,000 shares of $2 par value ordinary
shares
at $14 per share.
e. The basic advantage of being publicly owned is that the corporation has the opportunity to
raise large amounts of equity from many investors. Some publicly owned corporations
have millions of shareholders, including pension funds, mutual funds, and other
corporations. Private corporations are usually unable to raise the large amounts of capital
available to publicly owned corporations.
The primary disadvantages of being publicly owned are the increased governmental
regulations and financial reporting requirements.
f. The term convertible means that at the option of the preference shareholder, each
preference share can be converted into a specified number of ordinary shares. To evaluate
the value of this conversion feature, the shareholder must know into how many shares of
ordinary each preference share can be converted. This information is disclosed in the notes
accompanying the corporation’s financial statements.
g. At $248 per share, Parson's preference share has a dividend yield of 6.9% ($17.20 ¸ $248).
In comparison, an 8%, $50 par preference selling at $57 has a dividend yield of 7% [(8% x
$50 par) ¸ $57].
The dividend yield on preference shares indicates how much investors value certain
features of the shares. The lower the yield, the more investors favor the shares. A
higher yield means that investors demand a higher return to induce them to purchase
the shares.
The two principal factors that cause one preference share to yield less than another are: (1)
the appearance of greater ability to pay the preference dividends each year, and (2) special
features that appeal to investors, such as Parson’s conversion feature, cumulative
dividends, or a high call price.
a. Par value is the legal capital per share—the amount by which shareholders’ equity cannot be
reduced except by losses. Thus, par value may be viewed as a minimum cushion of equity
capital existing for the protection of creditors.
Book value per share is equal to the net assets represented by each ordinary
share. Book value is a historical cost concept, representing the amounts invested by
the shareholders, plus the amounts earned and retained by the corporation. By
comparing book value with current market value, shareholders may gain insight into
whether management has increased or diminished the value of the resources
entrusted to their care.
The market value of a share is established in the marketplace. It represents the per-share
price at which willing sellers can and will sell shares to willing buyers. Market value is
related primarily to investors’ future expectations of the company’s performance, rather
than to historical amounts.
b. The company’s par value—one-tenth of a cent per share—is quite low. However, the
corporation can set par value at any level that it chooses; the amount of par value has
no direct effect upon either book value or market value. It does mean, however, that
the amount of the company’s legal capital—serving as a cushion for creditors—is quite
low. Another reason for the small par value is the possibility of share splits in the past.
The fact that book value per share ($6.50) is far above par value indicates either that (1)
the shares initially was issued at a price far above par value, or (2) that the company has
retained substantial amounts of earnings. Even if there had been share splits in prior
years, the total dollar amount of book value would not have been affected.
The market value of $65 is 10 times book value. This implies that investors believe that
management and product lines make the company worth far more than the amounts of
capital historically invested.
The very low par value offers little protection to the company’s creditors. On the other
hand, a market value of many times book value implies that little cushion is required for
creditors’ claims to be secure. If the company performs as its market price implies that it
will, its earnings and cash flows should make the creditors’ positions quite secure.
Earnings and cash flows are far more relevant to a company’s debt-paying ability than is
the cushion provided by par value.
Shareholders’ equity:
Ordinary shares, $1 par, 50,000 shares authorized, issu $ 50,000
outstanding
Share premium: Ordinary shares 350,000
Share premium: Treasury shares 5,000
Total issued and fully paid capital $ 405,000
Retained earnings* 185,000
Total shareholders’ equity $ 590,000
b. The company’s book value per share is $11.80 ($590,000 total shareholders’ equity ¸ 50,000
shares outstanding).
c. The treasury shares purchase of $35,000 in 2008 was reported as a financing cash outflow in
the statement of cash flows for that year. The reissue of the treasury shares for $40,000 in the
following year was reported as a financing cash inflow in the 2009 statement of cash flows.
a.
Shareholders’ equity:
10% preference shares, $100 par, cumulative, authorized,
issued, and outstanding 30,000 shares $ 3,000,000
Ordinary shares, $10 par, 200,000 shares authorized,
120,000 shares issued, of which 10,000 shares are held in
treasury 1,200,000
Share premium: Ordinary shares 720,000
Share premium: Treasury shares* 50,000
Total issued and fully paid capital $ 4,970,000
Retained earnings** 1,925,000
Subtotal $ 6,895,000
Less: Treasury shares (10,000 shares x $20 cost per share) 200,000
Total shareholders’ equity at Dec. 31, 2009 $ 6,695,000
b. The company’s book value per share is approximately $33.59 ($6,695,000 total shareholders’
equity - $3,000,000 of preference shares book value = $3,695,000; $3,695,000 ¸ 110,000 shares
outstanding = $33.59).
c. Had the company decided to split its ordinary shares 3-for-1 on December 31, 2009, the market
value would have fallen to approximately $10 per share ($30 ¸ 3). The par value would have
been reduced to $3.33 ($10 ÷ 3), and the number of shares outstanding would have increased to
330,000 shares (110,000 x 3).
b. The market price of preference shares usually decreases as interest rates increase. Thus, at
December 31, 2009, the market price of Septa's preference shares was probably lower than
its call price of $110 (in fact, it may actually have fallen below its original price of $100 per
share.
b. A corporation might decide to use preference shares rather than debt to finance operations for any of
the following reasons (only 2 required):
1. Dividends do not have to be paid each year and do not become a legal obligation of the
corporation until they are declared. Interest on debt is a legal obligation of the
corporation and must be paid each year.
2. Debt must be repaid at some future date. To be a permanent source of capital, debt must
be periodically refinanced. Preference shares generally does not mature.
3. Increasing the amount of debt on a balance sheet can adversely affect financial ratios.
$ 1,000,000
320,000
130,000
1,820,000
$ 3,270,000
1,193,000
$ 4,463,000
$ 530,000
1,400,000
$ 1,930,000
(200,000)
(60,000)
(377,000)
$ 1,293,000
20__
Jan 7 Cash 300,000
Ordinary Shares 30,000
Share Premium: Ordinary Shares 270,000
Issued 30,000 shares of $1 par value ordinary
shares
at $10 per share.
e. The basic advantage of being publicly owned is that the corporation has the opportunity to
raise large amounts of equity capital from many investors. Some publicly owned
corporations have millions of shareholders, including pension funds, mutual funds, and
other corporations. Private corporations are usually unable to raise the large amounts of
capital available to publicly owned corporations.
The primary disadvantages of being publicly owned are the increased governmental
regulations and financial reporting requirements.
f. The term convertible means that at the option of the preference sharesholder, each
preference share can be converted into a specified number of ordinary shares. To evaluate
the value of this conversion feature, the shareholder must know into how many shares of
ordinary each preference share can be converted. This information is disclosed in the notes
accompanying the corporation’s financial statements.
g. At $190 per share, Toasty’s preference has a dividend yield of 5.26% ($10 ¸ $190). In
comparison, a 6%, $50 par preference selling at $52 has a dividend yield of 5.77% [(6% ´
$50 par) ¸ $52].
The dividend yield on preference shares indicates how much investors value certain
features of the shares. The lower the yield, the more investors favor the shares. A
higher yield means that investors demand a higher return to induce them to purchase
the shares.
The two principal factors that cause one preference to yield less than another are: (1) the
appearance of greater ability to pay the preference dividends each year, and (2) special
features that appeal to investors, such as Toasty’s conversion feature, cumulative
dividends, or a high call price.
a. Par value is the legal capital per share—the amount by which shareholders’ equity cannot be
reduced except by losses. Thus, par value may be viewed as a minimum cushion of equity
capital existing for the protection of creditors.
Book value per share is equal to the net assets represented by each ordinary share. Book
value is a historical cost concept, representing the amounts invested by
the shareholders, plus the amounts earned and retained by the corporation. By
comparing book value with current market value, shareholders may gain insight into
whether management has increased or diminished the value of the resources
entrusted to their care.
The market value of a share is established in the marketplace. It represents the per-share
price at which willing sellers can and will sell shares of the share to willing buyers. Market
value is related primarily to investors’ future expectations of the company’s performance,
rather than to historical amounts.
b. The company’s par value—five cents per share—is quite low. However, the
corporation can set par value at any level that it chooses; the amount of par value has
no direct effect upon either book value or market value. It does mean, however, that
the amount of the company’s legal capital—serving as a cushion for creditors—is quite
low. Another reason for the small par value is the possibility of share splits in prior years.
The fact that book value per share ($10.00) is far above par value indicates either that (1)
the share initially was issued at a price far above par value, or (2) that the company has
retained substantial amounts of earnings. Even if there had been share splits in prior
years, the total dollar amount of book value would not have been affected.
The market value of $96 is 9.6 times book value. This implies that investors believe that
management and product lines make the company worth far more than the amounts of
capital historically invested.
The very low par value offers little "cushion" to the company’s creditors. On the other
hand, a market value of many times book value implies that little cushion is required for
creditors’ claims to be secure. If the company performs as its market price implies that it
will, its earnings and cash flows should make the creditors’ positions quite secure.
Earnings and cash flows are far more relevant to a company’s debt-paying ability than is
the cushion provided by par value.
Shareholders’ equity:
Ordinary shares, $3 par, 50,000 shares authorized, issu $ 150,000
outstanding
Share premium: Ordinary shares 350,000
Share premium: Treasury shares 10,000
Total issued and fully paid capital $ 510,000
Retained earnings* 330,000
Total shareholders’ equity $ 840,000
b. The company’s book value per share is $16.80 ($840,000 total shareholders’ equity ¸ 50,000
shares outstanding).
c. The treasury shares purchase of $30,000 in 2008 was reported as a financing cash outflow in
the statement of cash flows for that year. The reissue of the treasury shares for $40,000 in the
following year was reported as a financing cash inflow in the 2009 statement of cash flows.
a.
Shareholders’ equity:
6% preference shares, $100 par, authorized and
issued and outstanding 10,000 shares $ 1,000,000
Ordinary shares, $20 par, 100,000 shares authorized,
80,000 shares issued, of which 400 shares are held in
treasury 1,600,000
Share premium: Ordinary shares 1,200,000
Share premium: Treasury shares* 6,000
Total issued and fully paid capital $ 3,806,000
Retained earnings** 3,261,440
Subtotal 7,067,440
Less: Treasury shares (400 shares x $40 cost per share) 16,000
Total shareholders’ equity at Dec. 31, 2009 $ 7,051,440
b. The company’s book value per share is approximately $76.02 ($7,051,440 total shareholders’
equity - $1,000,000 of preference shares book value = $6,051,440; $6,051,440 ¸ 79,600 shares
outstanding = $76.02).
c. Had the company decided to split its ordinary share 2-for-1 on December 31, 2009, the market
value would have fallen to approximately $28 per share ($56 ÷ 2). The par value would have
been reduced to $10.00 ($20 ÷ 2), and the number of shares outstanding would have increased
to 159,200 shares (79,600 x 2).
a. The market price of the 10%, $100 par value preference shares may be expected to decline
gradually as long-term interest rates rise. The market price of preference shares tends to vary
inversely with the level of interest rates.
b. If ADM’s profitability increases dramatically, the market price of its ordinary share
probably will rise significantly. The improved profitability of the company may lead to
larger increases in the dividends paid to ordinary shareholders than the 5 and 10 cent
increases of prior years. The market price of ordinary share is strongly affected by such
factors as the company’s expected future earnings and the probable rate of future
ordinary share dividends.
c. The market price of the 7%, $100 par value convertible preference shares should rise
approximately in proportion to the increase in the market value of the ordinary share. This
issue of preference shares is already deriving much of its market value from its conversion
feature, as indicated by the fact that its market price ($125) exceeds the market price of
ADM’s 10% preference shares ($90), which pays a higher dividend.
The current market price of the convertible preference shares is too high to be explained by
its $7 per year dividend, and it is approximately three times the current market price of the
ordinary share. Therefore, each share of this preference shares probably is convertible into
about three shares of ordinary share. As the market price of the ordinary share increases, the
market price of the convertible preference should also increase to remain approximately
equal in value to three shares of ordinary share.
b. The fall in the price of HSBC’s ordinary shares probably is based on two factors. The increase in the
default risk signals a general increase in interest rates which will affect the required yield on all
investments. Since investors will demand a higher yield on their investments, share and bond prices may
suffer an overall decline.
As a financial institution, this increase in the defaults has additional significance to HSBC. The increase
in the discount rate increases HSBC’s financial strength, which will reduce its profit, at least in the short
run. This reduction in expectations about future earnings will further reduce the bank’s share price.
c. The close down of research center signaled to the market that GlaxoSmithKline may be having
problems with its investment in research and development. Therefore, investors are reducing their
expectations of the company’s future earnings and increasing their assessments of the risk of the
business. This caused the share price to drop.
We do not provide comprehensive solutions for group problems that involve interviews. But the
following items normally come to light in our classes.
• Students may find that many people entered a business without giving much thought to the
form of entity.
• Among the “unforeseen complications” that often come to light are the problems when
partners do not see eye to eye, and the costs and complications resulting from the
corporation being a taxable entity.
• The normal reason why a business may change its form of entity is to attract more
capital.
• Some students may encounter professional corporations, which often are used by one or
more members of a partnership. These professional corporations are intended to limit the
individuals’ personal liability—although they require the individual to carry “malpractice”
insurance and do not exonerate them from liability for some types of professional
misconduct. They may also encounter S corporations, which, for tax purposes, are treated as
unincorporated organizations.
(c) The publication is "Does price information tell all?" under monthly focus on February 2010.
(d) Investor has to pay attention to the timeliness of market data and cross check different
financial ratios through the latest financial reports and announcements. In addition to price
information, investors should also look at other corporate actions that also affect the price
movements of stocks.
The recent market manipulation verdicts have sent the a clear message to all market
participants that market manipulation is a serious offence and that perpetrators could be
prosecuted and sent to jail for such actions. It is imperative that all market participants
operate with fairness and integrity on the markets.