Chapter 13, Problem 5BTN

To determine

Concept Introduction:

Common Stockholder: Common stockholders are considered as the owner of the company but when it comes to dividend, they come after preference stockholders.

Cumulative Preferred Stock: Preference stockholders are preferred first at the time of distribution of dividend. The dividends on cumulative preference stock are fixed and compulsory and if it not paid, it accumulates over the years.

Requirement 1:

If the new business is expected to earn $72,000 of after-tax net income in the first year, what rate of return on beginning equity will the founder earn under each alternative plan? Which plan will provide the higher expected return?

To determine

Concept Introduction:

Common Stockholder: Common stockholders are considered as the owner of the company but when it comes to dividend, they come after preference stockholders.

Cumulative Preferred Stock: Preference stockholders are preferred first at the time of distribution of dividend. The dividends on cumulative preference stock are fixed and compulsory and if it not paid, it accumulates over the years.

Requirement 2:

Compute the rate of return under each alternative, if the net income after tax is $16,000 and determine which plan results in higher expected return?

To determine

Concept Introduction:

Cumulative preference shares: The preference share on which payment of dividend is compulsory, otherwise accumulates over the year is called cumulative preference shares. The rate of dividend on preference shares are fixed like interest expense on debt funds.

Requirement 3:

Analyze and interpret the difference between the results for parts 1 and 2.