Book 1 - Chapter 29

Discussion Questions and Brief Exercises

Legal capital is a specified dollar amount from a stock issuance that is required by state law to be
maintained in a corporation, and it cannot be reduced by dividends or other stockholder
distributions. This is for the protection of creditors. Par value is one way that the amount of legal
capital can be specified. Par value is a minimum amount per share that the purchaser of the stock
must pay for the stock, and it also establishes the maximum liability per share for each
stockholder. For common stock, the par value is usually set at some very low amount and has no
relation to market value of a share. (Remember: Par value is not the market value of stock!)

Paid-in capital is the part of stockholders’ equity that has been invested in the business. Retained
earnings is the part of the stockholders’ equity claim that represents the cumulative amount of net
income that is still retained in the business. If cumulative losses exceed cumulative profits,
retained earnings will be a negative amount.

Generally, the most an investor can lose is the amount invested. There are some limited exceptions
to this if an investor as an officer or employee of the corporation is involved in fraud, extreme
negligence, or violation of laws related to corporate activities. An investor’s personal liability to
creditors is generally limited to the amount of the stock value that was designated as legal capital.
Usually this is much less than the total amount that was invested.

a.	(10,000 × $100 × .05) = $50,000
b.	(10,000 × $100 × .05) / 4 = $12,500
c.	(10,000 × $100 × .05 × 2) + (10,000 × $100 × .05) / 4 = $112,500

The cash dividend will be paid on April 20. To receive the dividend, an investor’s name must be
formally recorded as an owner no later than March 31. Generally an investor would have to
purchase the stock more than two business days before the date of record before the date of
record to allow enough time for recording the purchase. The two-day prior date is called the
“ex-dividend” date. Here, it would be March 29.

a.	(5,000 × $104) = $520,000
b.	(5,000 × $104) + (5,000 × $4) / 4 = $525,000
c.	(5,000 × $104) + (5,000 × $4 × 2) + (5,000 × $4) / 4 = $565,000

Stock is called “preferred” when it has preferences over common stock. Usually, preferred stock
has a dividend preference and a liquidation preference over common stock. This means that
preferred stock will be the first to receive dividends and also will receive corporate assets before
common stock in the case of liquidation. Usually preferred stock is non-voting, whereas common
stockholders have the right to vote. Also, preferred stock is often cumulative and may also be
callable and convertible into common shares. Generally, preferred stock receives a fixed dividend
amount, whereas common stock dividends fluctuate more and potentially can be much greater
than preferred stock.

Preferred stock is issued to appeal to the interests of different types of shareholders—usually
investors who are less speculative and who want fixed, predictable dividends. By appealing to
different types of investors, a corporation is able to obtain more money from investors. This is
the usual reason that all different classes of stock are created.

Par value, preferred stock: The minimum amount that must be invested (legal capital) for preferred stock.
Par value, common stock: The minimum amount that must be invested (legal capital) for common stock.
Paid-in capital in excess of par, common and preferred stock: Amounts invested that exceed par value.
No par common stock: Common stock issued without a par value (no minimum amount).
Common stock subscribed: The par value or portion of no-par value of common shares that have been subscribed but not yet fully paid for.

Learning Goal 29, continued

SOLUTIONS

Section VI · Corporations

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