Iders closely monitor dividend payments it is

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iders closely monitor dividend payments. It is generally perceived that the level of dividend _ments is related to the company's expected long-term recurring income. Accordingly, dividend ases are usually viewed as positive signals about future performance and are accompanied _ tack price increases. By that logic, companies rarely reduce their dividends unless absolutely sary because dividend reductions are often met with substantial stock price declines. ancial Effects of Cash Dividends - h dividends reduce both cash and retained earnings by the amount of the cash dividends paid. illustrate, assume that Aon declares and pays cash dividends in the amount of $10 million. The cial statement effects of this cash dividend payment are as follows: Balance Sheet Income Statement "'- Net Income Rev- enues Cash Asset + Noncash Assets Liabil- + Contrib. + Earned ities Capital Capital Expen- ses Transaction ~~ \ --"$10 mil- -10 mil. -10 mil. 'I Cash = Retained ( in cash Earnings _.'~~~.~.~ l. . = Dividend payments do not affect net income. They directly reduce retained earnings and bypass income statement. Dividends on preferred stock have priority over those on common stock, including unpaid prior _ears' preferred dividends (called dividends in arrears) when preferred stock is cumulative. To illus- rrate, assume that a company has 15,000 shares of $50 par value, 8% preferred stock outstanding; RE to mn. Cash 10 mil. RE 10mil. I Cash 10 mil.
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8-17 Module 8 I Equity Recognition and Owner Financing assume that the preferred stock is cumulative, which means that any unpaid dividends cumulate and must be paid before common dividends. The company also has 50,000 shares of $5 par value com- mon stock outstanding. During its first three years in business, assume that the company declares $20,000 dividends in the first year, $260,000 of dividends in the second year, and $60,000 of divi- dends in the third year. Cash dividends paid to each class of stock in each of the three years follows; Preferr~d Year 1-$20,000 cash dividends paid Current-year dividend (15,000 shares x $50 par x 8%; but only $20,000 paid, leaving $40,000 in arrears) ............... •... $20,000 Balance to common ................................ •... Year 2-$260,000 cash dividends paid Dividends in arrears from Year 1 ([15,000 shares x $50 par x 8%] - $20,000) . . . . . . . . . . •... . 40,000 Current-year dividend (15,000 shares x $50 par x 8%) . . . . . .. . ... •... 60,000 Balance to common. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year 3-$60,000 cash dividends paid Current-year dividend (15,000 shares x $50 par x 8%) . . . . . .. . . . .. .. . .. 60,000 Balance to common ........................................ ..... $ 0 The solution is on page 8-49. 160,000 o MID-MODULE REVIEW 2 Assume that Accenture (ACN) has outstanding 10,000 shares of $100 par value, 5% preferred stock -and 50,000 shares of $5 par value common stock. During its first three years in business, assume that Accenture declared no dividends in the first year, $300,000 of cash dividends in the second year, and $80,000 of cash dividends in the third year. If preferred stock is cumulative, determine the dividends paid to each class of stock for each of the three years.
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