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Sources of Assets . Borrowing (Current Debt and Long-term Notes and Bonds Payable- Chapters 10 and 11)

Financial Management. Chapter 12. Stockholders’ Equity Taipei Howard Godfrey, Ph.D., CPA UNC Charlotte Copyright © 2009, Dr. Howard Godfrey Edited May 16, 2009. Sources of Assets . Borrowing (Current Debt and Long-term Notes and Bonds Payable- Chapters 10 and 11)

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Sources of Assets . Borrowing (Current Debt and Long-term Notes and Bonds Payable- Chapters 10 and 11)

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  1. Financial Management.Chapter 12. Stockholders’ EquityTaipeiHoward Godfrey, Ph.D., CPAUNC CharlotteCopyright © 2009, Dr. Howard GodfreyEdited May 16, 2009

  2. Sources of Assets. • Borrowing(Current Debt and Long-term Notes and Bonds Payable- Chapters 10 and 11) • Contributed capital(Common Stock andPreferred Stock) • Earned Capital(Retained Earnings)

  3. Sources of Assets. Text pg 504. Note the relative importance of debt, contributed capital and earned capital for these well known companies. How can retained earnings be negative? (see Amazon- Pg. 513. More on that later.)

  4. Before focusing on the Financial Management issues related to owner equity, we will record the transactions for a small, hypothetical start-up company and prepare its financial statements. Lets move forward with the Hat Corp. case on the slides that follow. Then we will address specific financial management issues.

  5. Hat Corporation – Slide 1. Please study the transactions on the next slide for Hat Corporation in its first year of operations. The corporation provides a service on credit. Hat owns no building or equipment. Hat rents all needed equipment, office space, etc. 1. Prepare the journal entries for Hat Corporation on the slides provided after the transaction slide. 2. Post the entries to the T accounts. 3. Prepare financial statements.

  6. Sources of Assets.Textbook page 513. Which corporation (on page 513) does Hat Corporation most closely resemble, in terms of the relative importance of debt, contributed capital and earned capital?

  7. Book Value of Stock.Textbook page 523. What is the book value per share of the stock of Hat Corporation? See earlier slide? (Also next slide) Is that also the market value?

  8. Book Value. Textbook page 514.Note that the book value of common was $50 per share when the corporation was first organized. Hat earned $25,000 of net income, which is $25 for each of the 1,000 shares. This is earnings per share of $25. Book value increased from $50 per share to $75 per share. What is its par value? Market to Book Ratio. Textbook page 524. If this stock is selling for $150 per share, what is the Market to Book Ratio?

  9. Preferred Stock. Text page 512. On December 31, 2007, Hat Corporation will raise an additional $50,000 in cash by issuing preferred stock (500 shares of $100 par, 6%, cumulative) What does this mean? The cash will be used to buy equipment. How will it affect the Balance sheet. Please study the next slide.

  10. Debt Equity Ratio. How was the debt/equity ratio of the Hat Corp. affected by its decision to raise an additional $50,000 in cash by issuing preferred stock (500 shares of $100 par, 6%, cumulative)? Use ending balances rather than average balances to compute the debt/equity ratio. See next slide.

  11. Debt and Equity Distinguished.Textbook page 522. In an earlier case, a manufacturer of racing engines was financed initially with funds invested by two mechanics (for 100% of the stock). Later a relative loaned the company the additional funds it needed for expansion and received a demand note receivable. What characteristics of debt financing were important to the relative? To the current owners?

  12. Concept of Leverage [1 of 2] A corporation has 1,000 shares of $100 par stock outstanding. No retained earnings. (Equity of $100,000). The Corporation earns a net income of $10,000 per year (ROE is 10%). Earnings per share is $10. The market expects a 10% return, so the market price of the stock is $100 per share. Corporation needs to expand by investing an additional $100,000 in the business. Corporation will earn 10% on the additional investment before interest expense. Corporation will borrow the $100,000 at 6% interest. What is new earnings per share?

  13. Big Corporation – Slide 1 of 10 The balance sheet at 1-1-2006 and budgeted income statement (for 2006) are presented on the next two slides. Big Corp. manufactures & sells 10,000 units of its product. Selling price is $10 per unit. Mfg. Cost is $5 per unit. Selling and Admin. Costs total $1 per unit. The income tax rate is 50%.

  14. Big Corp. Needs to Expand. 6 of 10 Big Corp. needs to double its productive capacity in order to supply its product to a new customer in a neighboring country. The new factory and equipment (New Venture) will cost $200,000. This venture is not included in the budget on preceding slides for Big Corp. The factory can be financed by issuing additional stock for $200,000 ($10 par to be issued at price of $25 per share- 8,000 shares), or by issuing 6% bonds for $200,000. Compare the impact of the expansion, if it is financed with stock or with bonds.

  15. Earnings per share. 8 of 10. Please compute earnings per share after this expansion, under both financing alternatives.

  16. Treasury Stock Pg 526+ Now lets change the topic to Treasury Stock. Please read the material on pages 526-529.

  17. Stock Corporation – 4 of 5 What was the impact of this purchase of treasury stock on earnings per share? (Fewer shares, higher EPS) What was the impact on the income statement (of the sale treasury stock for $40 per share when it cost the company $30 to buy it back)? (No impact.) We do not make profit off of our shareholders – We make profit for them.

  18. Stock Corporation – 5 of 5 How would you record the sale of treasury stock for $5 per share (instead of $40 per share as above)? See Page 528. Cash 5,000 Retained Earnings 25,000 Treasury Stock 30,000

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