Question

A firm has an outstanding issue of 1,000 shares of preferred stock with a $100 par value and an 8 percent annual dividend. The firm also has 5,000 shares of common stock outstanding. If the stock is cumulative and the board of directors has passed the preferred dividend for the prior two years, how much must the preferred stockholders be paid prior to paying dividends to common stockholders at the end of third year?

Answer 1

The firm must pay $24,000 in dividends to preferred stockholders at the end of the third year, which includes $16,000 in dividends in arrears from the past two years plus the current year's dividend of $8,000.

Step-by-step explanation:

When calculating dividends for cumulative preferred stock, it's essential to understand that preferred stockholders are entitled to their dividends before common stockholders can receive any. In this scenario, the firm has 1,000 shares of preferred stock with a $100 par value and an 8 percent annual dividend. The key point here is that the stock is cumulative, meaning that if dividends are not paid out in any year, they accumulate and must be paid out before any dividends can be distributed to common stockholders.

To calculate the dividends in arrears: Multiply the par value by the number of shares, which gives us the total value of the preferred stock, then find 8 percent of that total value to determine the annual dividend, and finally, multiply the annual dividend by the number of years dividends have been missed.

Calculation:
1. Total Par Value = 1,000 shares * $100 = $100,000
2. Annual Dividend = 8% * $100,000 = $8,000
3. Total Dividend in arrears for two years = 2 * $8,000 = $16,000

To determine how much must be paid at the end of the third year, the firm would need to pay the accumulated dividends for the two years that were missed ($16,000) plus the current year's dividend ($8,000), for a total of $24,000 in dividends to preferred stockholders.

Answer 2

“Hence, the amount that must be paid to the preferred stockholders be paid prior to paying dividends to common stockholders at the end of third year = $24,000”

Step-by-step explanation:

The Paid-up value of Preferred Shares = $100,000 [1,000 Shares x $100]

The Amount of Preferred Dividend per year = $8,000 [$100,000 x 8%]

The amount that must be paid to the preferred stockholders be paid prior to paying dividends to common stockholders at the end of third year

= Cumulative Preferred Dividends payable for the 2 years + Current Year Dividend

= [$8,000 x 2 Years] + $8,000

= $16,000 + 8,000

= $24,000

“Hence, the amount that must be paid to the preferred stockholders be paid prior to paying dividends to common stockholders at the end of third year = $24,000”