Question

When Crossett Corporation was organized in January, Year 1, it immediately issued 4,000 shares of $50 par, 6 percent, cumulative preferred stock and 50,000 shares of $20 par common stock. Its earnings history is as follows: Year 1, net loss of $35,000; Year 2, net income of $125,000; Year 3, net income of $215,000. The corporation did not pay a dividend in Year 1.

Required:
a. How much is the dividend arrearage as of January 1, Year 1?
b. Assume that the board of directors declares a $25,000 cash dividend at the end of year 1 (remember that the year 1 and year 2 preferred dividends are due). How will the dividend be divided between the preferred and common stockholders?

Answer 1

a. $0

The company was organized in January, Year 1. They do not have to pay dividends because the company just started operations. The cumulative dividends are only to be paid at the end of the period so there is no dividend arrear here.

b. Preferred shareholders are meant to get:

= 4,000 shares * 50 * 6%

= $12,000 per year

As they are owed $12,000 from the first year and are now owed for the second, the dividends they will get is:

= 12,000 + 12,000

Preferred Dividends = $24,000

Ordinary shareholders get what is left:

= 25,000 - 24,000

= $1,000