Accouting help?

Question

Hancock Corporation is a Publishing Company.  The Hancock Family formed this corporation in colonial times more than 200 years ago.  The stock (400 shares of $1 par common stock)  has remained in the hands of the Hancock Family for all of that time.  In recent years, the Company has experienced the need for additional paid in capital.   The Company has formulated a plan to issue 20,000 shares of 4% $50 par preferred stock.  The stock will be issued at par value resulting in an additional $1 million of paid in capital.  The preferred stock is cumulative and non-voting.

Is this plan ethical?  How much will the preferred dividends be each year?  What is the advantage for the Hancock Family?  If the Hancock Corporation pays out $100,000 in dividends, how much per share will go to the Preferred stockholders and how much per share will go to the common stockholders?

Answer

Preferred dividend will be 1,000,000*4% = 40,000 $ or 2 $ per preferred share whereas the ordinary shareholders will receive 60,000 USD or 150$ per share. The advantage for the family is that they get the necessary funding whilst retaining 100% control of the company which will allow them to pursue their strategy as they did in the last 200 years. 

Apparently, the proposal is not ethical. The return on the preferred shares seems disproportionately lower than the one attributable to ordinary shared. Even considering the inflation 1913-2015 of 2326% in the US (source: inflationdata.com) which is just a notch over 100 years we can approximate the actual value of the ordinary share to  23.26 $ x 200/102 = 46.52 $ which will give them a return of ~200% per share compared to a 4% offered to preferred shares holders.

However, the proposal needs to be analysed in some context. How does the return of 150% compare to the return the family got before the issuance of the preferred shares? If that is sensibly similar, then the plan might be ethical. Further, what is the risk profile of Hancock corporation and how the 4% return compares with the risk-free products returns? Assume the corporation is considered 99% risk-free and the return of the risk-free products at 0.1% per year. In such a case, and in correlation with the answer to the previous question, the plan would definitely be ethical in my opinion

Accouting help?

Answers (1)