question archive Lena Kay and Kathy Lauder have a patent on a new line of cosmetics
Lena Kay and Kathy Lauder have a patent on a new line of cosmetics
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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 incorpo-rating, 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. Journalize the issuance of common stock to Kay and Lauder. Explanations are not required.
2. Journalize the issuance of stock to the outsiders under both plans. Explanations are not required.
3. Net income for the first year is $180,000, and total dividends are $30,000. Prepare the stockholders' equity section of the corporation's balance sheet under both plans at the end of the first year.
4. Recommend one of the plans to Kay and Lauder. Give your reasons.
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Answer:
1. Patent Dr. 100,000
Common stock Cr. 100,000
Issuance of common stock to Kay and Lauder
2. Plan 1:
Cash Dr. 150,000
Preferred stock Cr. 150,000
Issuance of 1,500 shares of 6%, $100 par nonvoting, noncumulative preferred stock
Plan 2:
Cash Dr. 170,000
Preferred stock Cr. 100,000
Common stock Cr. 70,000
Issuance of 1,000 shares of 5%, no-par preferred stock and 70,000 shares of common stock
3. Plan 1:
Stockholders' Equity
Capital stock:
Preferred stock, $100 par value, 5,000 shares authorized,
1,500 shares issued and outstanding $150,000
Common stock, $1 par value, 500,000 shares authorized,
100,000 shares issued and outstanding 100,000
Retained earnings 150,000
Total stockholders' equity $400,000
Plan 2:
Capital stock:
Preferred stock, no-par, 5,000 shares authorized,
1,000 shares issued and outstanding $100,000
Common stock, $1 par value, 500,000 shares authorized,
170,000 shares issued and outstanding 170,000
Retained earnings 150,000
Total stockholders' equity $420,000
4. Kay and Lauder's primary goal is to raise as much capital as possible without giving up control of the business. Thus, I would recommend Plan 1 to them since it is the best option to fulfill the goal. In Plan 1, they will still have full control as the stocks issued are nonvoting, whereas in Plan 2, they will be giving up control since preferred shares have 50 votes on matters before the common stockholders and there are 70,000 common stock issued as well.
PFA
