Question

Enterprise Storage Company has 520,000 shares of cumulative preferred stock outstanding, which has a stated dividend of $5.75. It is six years in arrears in its dividend payments. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. How much in total dollars is the company behind in its payments? (Do not round intermediate calculations. Input your answer in dollars, not millions (e.g., $1,234,000).)
b. The firm proposes to offer new common stock to the preferred stockholders to wipe out the deficit. The common stock will pay the following dividends over the next four years: D1 $1.55 D2 1.65 D3 1.75 D4 1.85 The company anticipates earnings per share after four years will be $4.17 with a P/E ratio of 12. The common stock will be valued as the present value of future dividends plus the present value of the future stock price after four years. The discount rate used by the investment banker is 13 percent.Compute the value of the common stock. (Do not round intermediate calculations and round your answer to 2 decimal places.)c. How many shares of common stock must be issued at the value computed in part b to eliminate the deficit (arrearage) computed in part a? (Do not round intermediate calculations and round your answer to the nearest whole share.)

Answer 1

a. How much in total dollars is the company behind in its payments?

$2,990,000 per year x 6 years = $17,940,000

b. The firm proposes to offer new common stock to the preferred stockholders to wipe out the deficit. The common stock will pay the following dividends over the next four years: D1 $1.55 D2 1.65 D3 1.75 D4 1.85 The company anticipates earnings per share after four years will be $4.17 with a P/E ratio of 12. The common stock will be valued as the present value of future dividends plus the present value of the future stock price after four years. The discount rate used by the investment banker is 13 percent.Compute the value of the common stock.

PV of dividends = $1.55/1.13 + $1.65/1.13² + $1.75/1.13³ + $1.85/1.13⁴ = $1.3717 + $1.2922 + $1.2128 + $1.1346 = $5.01

share price after 4 years = $4.17 x 12 = $50.04

PV of future price = $50.04/1.13⁴ = $30.69

current stock price = $35.70

c. How many shares of common stock must be issued at the value computed in part b to eliminate the deficit (arrearage) computed in part a?

= $17,940,000 / $35.70 = 502,521 stocks

Step-by-step explanation:

520,000 cumulative preferred stocks outstanding x $5.75 = $2,990,000 in preferred dividends per year