Finance Chapter: Debt and Equity

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Questions and Answers

What is the total cash amount received from selling 80 shares at $24 each?

$1,920 (correct)

$2,080

$2,240

$1,760

What amount was recorded as additional paid-in capital from the transaction?

$1,760

$1,920

$160 (correct)

How often are cash dividends typically paid by companies?

Annually

Quarterly (correct)

Semi-annually

Monthly

What was the declared dividend per share by Pfizer for the first quarter of 2021?

$0.39 Signup and view all the answers

What is NOT a reason for paying dividends according to the provided information?

To meet debt covenant restrictions Signup and view all the answers

What is the primary reason for a company to repurchase its own stock?

To signal that the stock may be undervalued Signup and view all the answers

What does the treasury stock account represent on the balance sheet?

A contra equity account Signup and view all the answers

When a company reissues treasury stock, how is the difference between the cost and resale price recorded?

As an adjustment to additional paid-in capital Signup and view all the answers

In the case of Phelps Swimming, Inc., what were the total cash transactions when repurchasing 100 shares at $22 per share?

$2,200 Signup and view all the answers

What effect does treasury stock have on the number of shares outstanding?

Reduces the number of shares outstanding Signup and view all the answers

What is the impact of treasury stock on a company's income statement?

It has no effect Signup and view all the answers

If Phelps Swimming, Inc. reissues 80 shares of its treasury stock for $24 each, what is the cash received from the reissue?

$2,400 Signup and view all the answers

What is one potential result of repurchasing shares that can benefit shareholders?

Increased earnings per share Signup and view all the answers

What does EPS represent in a company?

Earnings available per common share for dividends Signup and view all the answers

What was Phelps Swimming's basic EPS for the year 20X9?

$0.95 Signup and view all the answers

Why does diluted EPS typically show a lower value than basic EPS?

It accounts for convertible securities and options Signup and view all the answers

How are the shares considered in the diluted EPS calculation?

All convertible securities and stock options are included Signup and view all the answers

If Phelps Swimming had not issued any convertible preferred stock, how would this impact their diluted EPS?

It would likely increase Signup and view all the answers

What distinguishes equity from debt in terms of legal agreements?

Equity does not have a fixed maturity date. Signup and view all the answers

Which component is included in earned capital?

Retained earnings Signup and view all the answers

What is the primary purpose of issuing stock?

To obtain cash and other assets. Signup and view all the answers

Which statement about preferred stock is incorrect?

Preferred shareholders can vote in corporate decisions. Signup and view all the answers

What are the authorized shares of a corporation?

The maximum number of shares that can be issued. Signup and view all the answers

How are dividends characterized in relation to equity?

They are discretionary incomes. Signup and view all the answers

What happens to retained earnings when a company incurs a net loss?

It decreases. Signup and view all the answers

What defines a company’s outstanding shares?

Issued shares minus treasury stock. Signup and view all the answers

Which statement about common stock is true?

It is the primary ownership unit in a company. Signup and view all the answers

What is the effect of issuing stock on a company’s financial statements?

No effect on the income statement. Signup and view all the answers

What effect does declaring a cash dividend have on a company's profit?

No effect on profit Signup and view all the answers

How is Other Comprehensive Income (OCI) displayed in a company's financial statements?

In the Shareholders’ Equity section of the balance sheet Signup and view all the answers

What is a characteristic of a company with a complex capital structure?

It includes dilutive securities like convertible preferred stock Signup and view all the answers

Why are preferred dividends and noncontrolling interests subtracted when calculating Basic Earnings Per Share (EPS)?

They are not considered part of common shareholders' earnings Signup and view all the answers

What is a primary financial statement effect of a stock split?

It creates additional shares without financial statement effects Signup and view all the answers

Which scenario would require the calculation and reporting of Diluted Earnings Per Share (EPS)?

Dilutive securities like stock options are outstanding Signup and view all the answers

What happens to retained earnings when a stock dividend is declared?

It is reduced Signup and view all the answers

In calculating Basic EPS, what is the denominator used?

Weighted average number of common shares outstanding Signup and view all the answers

Study Notes

Chapter Objectives

Able to describe the characteristics of debt and equity
Able to describe the components of Shareholders' Equity
Able to account for stock issuance and repurchase (Treasury Stock)
Able to explain stock dividends and stock splits
Able to discuss Other Comprehensive Income items
Able to describe basic and diluted EPS

How to Finance a Corporation

Borrow: Examples include notes, bonds, and leases. Debt holders are legally entitled to repayment of interest and principal.
Issue Equity: Includes common and preferred stock. Shareholders have various rights, limited liability, and a residual interest in corporate assets. Internally generated cash also funds corporations.

Debt versus Equity

Feature	Debt	Equity
Contract	Formal legal contract	No legal contract
Maturity	Fixed maturity date	No fixed maturity date
Payments	Fixed periodic payments	Discretionary dividends
Default Security	Security in case of default	Residual asset interest
Management	No voice in management	Voting rights
Deductibility	Interest expense deductible	Dividends not deductible
Taxation	Common	Double taxation

Pfizer's Stockholders' Equity

Provided data on preferred stock, common stock, additional paid-in capital, treasury stock, retained earnings, and accumulated other comprehensive loss for Pfizer as of December 31, 2020. The data is in millions, except for preferred stock issuance and per common-share data.

Contributed Capital

Represents the cumulative cash inflows from issuing various classes of stock.
Less the net cash paid to repurchase a company's own stock in the market.
Includes two classes of stock, common and preferred stock, and additional paid-in capital (also called Paid-in capital in excess of par).

Earned Capital

Represents the cumulative profits and losses of a company, less any dividends paid to shareholders.
Includes Other Comprehensive Income (OCI) which is changes to equity that are not part of the income statement and not reflected in retained earnings

Retained Earnings

Represents the cumulative profit retained by the company.
Increased by net income.
Decreased by net losses.
Decreased by dividends paid to shareholders.
Affected by other events.

Common Stock

The primary ownership unit in a company.
Common shareholders have voting rights.
Par value: An arbitrary value assigned to each share of stock. It is specified in the corporate charter when the company is formed and determines the allocation of proceeds from stock issuance on the balance sheet.

Numbers of Shares of Stock

Authorized Shares: The upper limit on the number of shares a corporation can issue. It is established in the articles of incorporation and can be increased by a shareholder vote.
Issued Shares: The actual number of shares issued to shareholders.
Outstanding Shares: The number of issued shares, less the number of shares repurchased as treasury stock.

Preferred Stock

Generally has preference or priority over common stock.
Typical preferences: Dividend preference (preferred shareholders receive dividends before common shareholders), and liquidation preference (company assets first go to debtors, then preferred shareholders, then common).

Accounting for Stock Issuances

Used to obtain cash and other assets for business use.
Creates an increase in assets and stockholders' equity.
Common and/or preferred stock increases by par value multiplied by the number of shares sold.
Additional paid in capital increases by the remainder of the issue price.
No effect on the income statement.
The first issuance of stock is called an initial public offering (IPO).

Stock Repurchase (Treasury Stock)

A company buys its own stock from investors.
Reasons for repurchase:
- To reduce outstanding shares, which can increase the market value of remaining shares
- To offset the dilution effect of employee stock option programs

Accounting for Treasury Stock

Never results in a gain or loss on the income statement.
Differences between purchased and resold stock prices adjust additional paid-in capital.
Treasury stock is a contra stockholder's equity account. It's deducted from the total stockholders' equity amount on the balance sheet.

Cash Dividends

Reasons for dividend payments vary.
Most are paid in cash.
Most are paid quarterly.

Stock Dividends and Splits

Additional shares of stock are distributed to shareholders.
Stock dividends: Retained earnings is reduced; contributed capital increases.
Stock splits: No financial statement effects.

Other Comprehensive Income (OCI)

Includes foreign currency adjustments, unrealized gains/losses on available-for-sale securities/derivatives, and adjustments to pension and other benefit plans.
OCI is displayed separately on the balance sheet, under the stockholders' equity section,.

Reported on the face of the income statement.
At least one EPS amount is required; potentially two.
- Basic EPS: Always required.
- Diluted EPS: Required with complex capital structures.

Complex Capital Structure

Exists if dilutive securities, convertible securities that can be converted into common stock and reduce/dilute earnings per share.
Three primary types: Stock options, convertible debt, and convertible preferred stock.
Requires diluted EPS, which is calculated and reported in addition to basic EPS.

Calculating EPS

Basic EPS: Earnings available for common shareholders / weighted average number of common shares outstanding.
Preferred dividends and noncontrolling interests are subtracted.
Diluted EPS considers the effect of potential conversion of convertible securities or stock options into additional shares, increasing available shares, and thus reducing EPS.

Basic EPS Example/Diluted EPS Example

Provide examples of calculations using net income adjusted for preferred dividends and common dividends. These examples illustrate how to calculate earnings per share both basic and diluted. These include the impact of treasury stock and common shares.

Pfizer's EPS

Shows the basic and diluted EPS for Pfizer for the years ending December 31, 2020, and 2019, providing financial data and analysis for the company's income statement. Data includes earnings per common share, both basic and diluted. It shows how the company's earnings are distributed, considering the weighted average number of shares outstanding for both basic and diluted EPS.

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Description

This quiz covers the fundamentals of debt and equity financing in corporations. You will learn about the characteristics, components, and accounting practices related to stock issuance, repurchase, dividends, and earnings per share. Test your understanding of how corporations manage their finances through debt and equity.