Lena Kay and Kathy Lauder have a patent on a new line of cosmetics. They need additional capital to market the products, and they plan to incorporate the business. They are considering the capital structure for the corporation. Their primary goal is to raise as much capital as possible without giving up control of the business. Kay and Lauder plan to invest the patent (an intangible asset, which will be transferred to the company’s ownership in lieu of cash) in the company and receive 100,000 shares of the corporation’s common stock. They have been offered $100,000 for the patent, which provides an indication of the fair market value of the patent. The corporation’s plans for a charter include an authorization to issue 5,000 shares of preferred stock and 500,000 shares of $1 par common stock. Kay and Lauder are uncertain about the most desirable features for the preferred stock. Prior to incorporating, they are discussing their plans with two investment groups. The corporation can obtain capital from outside investors under either of the following plans:
Plan 1. Group 1 will invest $150,000 to acquire 1,500 shares of 6%, $100 par nonvoting, noncumulative preferred stock.
Plan 2. Group 2 will invest $100,000 to acquire 1,000 shares of $5, no-par preferred stock and $70,000 to acquire 70,000 shares of common stock. Each preferred share receives 50 votes on matters that come before the common stockholders. Requirements Assume that the corporation has been chartered (approved) by the state.
1. Net income for the first year is $180,000 and total dividends are $30,000. Discuss the preparation of the stockholders’ equity section of the corporation’s balance sheet for both plans.
2. Recommend one of the plans to Kay and Lauder. Give your reasons.