Chapter 17
Common and Preferred Stock Financing
Discussion Questions
17-1. Why has corporate management become increasingly sensitive to the
desires of large institutional investors?
Corporate management has become increasingly sensitive to the desires of
17-2. Why might a corporation use a special category such as founders’ stock in
issuing common stock?
Founders’ stock may carry special voting rights that allow the original
17-3. What is the purpose of cumulative voting? Are there any disadvantages to
management?
The purpose of cumulative voting is to allow some minority representation
17-4. How does the preemptive right protect stockholders from dilution?
The preemptive right provides current stockholders with a first option to
17-5. If common stockholders are the owners of the company, why do they have
the last claim on assets and a residual claim on income?
The actual owners have the last claim to any and all funds that remain. If
17-6. During a rights offering, the underlying stock is said to sell “rights-on” and
When a rights offering is announced, a stock initially trades rights-on, that
After a certain period of time (say four weeks), the stock goes ex-rights;
The significance to current and future stockholders is that they must decide
17-7. Why might management use a poison pill strategy?
A poison pill may help management defend itself against a potential
takeover attempt. When another company attempts to acquire the firm, the
17-8. Preferred stock is often referred to as a hybrid security. What is meant by
this term as applied to preferred stock?
Preferred stock is a “hybrid” or intermediate form of security possessing
some of the characteristics of debt and common stock. The fixed amount
17-9. What is the most likely explanation for the use of preferred stock from a
corporate viewpoint?
Most corporations that issue preferred stock do so to achieve a balance in
17-10. Why is the cumulative feature of preferred stock particularly important to
preferred stockholders?
With the cumulative feature, if preferred stock dividends are not paid in
any one year, they accumulate and must be paid in total before common
17-11. A small amount of preferred stock is participating. What would your
reaction be if someone said common stock is also participating?
The participation privileges of a few preferred stock issues mean that
preferred stockholders may receive a payout over and above the quoted rate
17-12. What is an advantage of floating rate preferred stock for the risk-averse
investor?
17-13. Put an X by the security that has the feature best related to the following
considerations. You may wish to refer to Table 17-4.
a. Ownership and control of the firm
b. Obligation to provide return
Common
Stock
Preferred
Stock
Bond
s
a. Owners and control of the
recipient
Chapter 17
Problems
1. Residual claims to earnings (LO17-1) Folic Acid Inc. has $20 million in earnings, pays
$2.75 million in interest to bondholders, and $1.80 million in dividends to preferred
stockholders.
a. What are the common stockholders’ residual claims to earnings?
b. What are the common stockholders’ legal, enforceable claims to dividends?
17-1. Solution:
Folic Acid Inc.
(in millions)
a. Earnings $20.00
b. None. The common stockholders have no legal, enforceable
2. Residual claims to earnings (LO17-1) Time Watch Co. has $46 million in earnings and is
considering paying $6.45 million in interest to bondholders and $4.35 million to preferred
stockholders in dividends.
a. What are the bondholders’ contractual claims to payment? (You may wish to review
Table 17-4.)
b. What are the preferred stockholders’ immediate contractual claims to payment? What
privilege do they have?
17-2. Solution:
Time Watch Co.
a. The bondholders have a legal contractual claim of
b. The preferred stockholders do not have an immediate
3. Poison pill (LO17-4) Katie Homes and Garden Co. has 10,640,000 shares outstanding.
The stock is currently selling at $52 per share. If an unfriendly outside group acquired 25
percent of the shares, existing stockholders will be able to buy new shares at 30 percent
below the currently existing stock price.
a. How many shares must the unfriendly outside group acquire for the poison pill to go
into effect?
b. What will be the new purchase price for the existing stockholders?
17-3. Solution:
Katie Homes and Garden Co.
a. 10,640,000 Total shares
b. $52 Current stock price
4. Cumulative voting (LO17-2) Mr. Meyers wishes to know how many shares are necessary
to elect 5 directors out of 14 directors up for election in the Austin Power Company. There
are 150,000 shares outstanding. (Use Formula 17-1 to determine the answer.)
17-4. Solution:
Austin Power Company
=
= 50,000 + 1 = 50,001 shares
5. Cumulative voting (LO17-2) Dr. Phil wishes to know how many shares are necessary to
elect 6 directors out of 14 directors up for election for the board of the Winfrey Publishing
Company. There are 340,000 shares outstanding. (Use Formula 17-1 to determine the
answer.)
17-5. Solution:
Winfrey Publishing Company
(Number of directors desired) ×
(Total number of shares outstanding)
Shares required = + 1
Total number of directors to be elected +1
=
6 × 340,000 2,040,000
+ 1 = + 1
14 + 1 15
= 136,000 + 1 = 136,001 shares
6. Cumulative voting (LO17-2) Carl Hubbell owns 6,001 shares of the Piston Corp. There
are 12 seats on the company board of directors, and the company has a total of 78,000
shares of stock outstanding. The Piston Corp. utilizes cumulative voting.
Can Mr. Hubbell elect himself to the board when the vote to elect 12 directors is held
next week? (Use Formula 17-2 to determine if he can elect one director.)
17-6. Solution:
Piston Corporation
= 1 director
7. Cumulative voting (LO17-2) Betsy Ross owns 927 shares in the Hanson Fabrics
Company. There are 15 directors to be elected. Thirty-three thousand five hundred shares
are outstanding. The firm has adopted cumulative voting.
a. How many total votes can be cast?
b. How many votes does Betsy control?
c. What percentage of the total votes does she control?
17-7. Solution:
Hanson Fabrics Company
Votes = Number of shares × Number of directors to be elected
8. Dissident stockholder group and cumulative voting (LO17-2) The Beasley Corporation
has been experiencing declining earnings, but has just announced a 50 percent salary
increase for its top executives. A dissident group of stockholders wants to oust the existing
board of directors. There are currently 14 directors and 32,500 shares of stock outstanding.
Mr. Wright, the president of the company, has the full support of the existing board. The
dissident stockholders control proxies for 15,001 shares. Mr. Wright is worried about losing
his job.
a. Under cumulative voting procedures, how many directors can the dissident
stockholders elect with the proxies they now hold? How many directors could they
elect under majority rule with these proxies?
b. How many shares (or proxies) are needed to elect nine directors under cumulative
voting?
17-8. Solution:
Beasley Corporation
a. Number of
directors
that can be
elected
(15,001 1) (14 1) 225,000 6
32,500 32,500
– ´ +
= = =
Six directors can be elected by the dissident stockholders
under cumulative voting.
b.
(Number of directors desired)´
(Total number of shares outstanding)
Shares Required = 1
Total number of directors to be elected +1 +
9 32,500 292,500
1 1 19,501 shares
14 1 15
´
= + = + =
+
9. Dissident stockholder group and cumulative voting (LO17-2) Midland Petroleum is
holding a stockholders’ meeting next month. Ms. Ramsey is the president of the company
and has the support of the existing board of directors. All 12 members of the board are up
for reelection. Mr. Clark is a dissident stockholder. He controls proxies for 34,001 shares.
Ms. Ramsey and her friends on the board control 44,001 shares. Other stockholders, whose
loyalties are unknown, will be voting the remaining 24,998 shares. The company uses
cumulative voting.
a. How many directors can Mr. Clark be sure of electing?
b. How many directors can Ms. Ramsey and her friends be sure of electing?
c. How many directors could Mr. Clark elect if he obtains all the proxies for the
uncommitted votes? (Uneven values must be rounded down to the nearest whole
number regardless of the amount.) Will he control the board?
d. If nine directors were to be elected, and Ms. Ramsey and her friends had 60,001
shares and Mr. Clark had 40,001 shares plus half the uncommitted votes, how many
directors could Mr. Clark elect?
17-9. Solution:
Midland Petroleum
a. Number of
directors
that can be
elected
(Shares owned 1)
(Total number of directors to be elected + 1)
=Total number of shares outstanding
– ´
(34,001 1) (12 1) 442,000 4
103,000 103,000
– ´ +
= = =
Mr. Clark can be assured of electing four directors.
b.
(44,001 1) (12 1) 44,000 13
103,000 103,000
– ´ + ´
=
572,000 5 directors
103,000
= =
c. Shares owned = Shares owned and proxies of other voters
(34,001 24,998 1) 13 58,998 13
103,000 103,000
+ – ´ ´
= =
766,974 7.4463 7 directors (rounded down)
103,000
= = =
He can only elect seven directors. Yes, Mr. Clark will
control the board.
d.
499,990 4.17 4 directors (rounded down)
120, 000
= = =
10. Strategies under cumulative voting (LO17-2) Mr. Michaels controls proxies for 40,000 of
the 75,000 outstanding shares of Northern Airlines. Mr. Baker heads a dissident group that
controls the remaining 35,000 shares. There are seven board members to be elected and
cumulative voting rules apply. Michaels does not understand cumulative voting and plans to
cast 100,000 of his 280,000 (40,000 × 7) votes for his brother-in-law, Scott. His remaining
votes will be spread evenly between three other candidates.
How many directors can Baker elect if Michaels acts as described in the preceding
paragraph? Use logical numerical analysis rather than a set formula to answer the question.
Baker has 245,000 votes (35,000 × 7).