Question

Santana Rey created Business Solutions on October 1, 2017. The company has been successful, and Santana plans to expand her business. She believes that an additional $86,000 is needed and is investigating three funding sources. 

⦁ Santana’s sister Cicely is willing to invest $86,000 in the business as a common shareholder. Since Santana currently has about $129,000 invested in the business, Cicely’s investment will mean that Santana will maintain about 60% ownership and Cicely will have 40% ownership of Business Solutions. 

⦁ Santana’s uncle Marcello is willing to invest $86,000 in the business as a preferred shareholder. Marcello would purchase 860 shares of $100 par value, 7% preferred stock. 

⦁ Santana’s banker is willing to lend her $86,000 on a 7%, 10-year note payable. She would make monthly payments of $1,000 per month for 10 years. 

Required 

⦁ Prepare the journal entry to reflect the initial $86,000 investment under each of the options (a), (b), and (c). 

⦁ Evaluate the three proposals for expansion, providing the pros and cons of each option. 

⦁ Which option do you recommend Santana adopt? Explain.

 

Answer 1

Step 1: Definition of Funding source

The funding sources means those sources by which the company can raise funds. Some famous funding sources are issuing common stock, preferred stock, and issuing notes Payable.

Step 2: Journal entries to reflect the initial $86,000 investment

(a)

Cash $86,000

         Common stock $86,000

Record issuance of common stock

 

 (b)

Cash $86,000

         Preferred stock $86,000

Record issuance of preferred stock

 

(c) 

Cash $86,000

         Notes payable $86,000

Record note payable

 

Step 3: Pros and cons of each funding source

Issuing common stock: - Common stock gives the owner voting rights and partial control over the company. On the other side, the company loses its control as after issuing common stock, stockholders own part of the company.

Issuing preferred stock: - Issuing preferred shares does not affect the control and ownership of the company. Companies always have to provide dividends over a regular period. The stockholders of preferred stock always have a preference at the time of winding up.

Notes payables: - It is a liability account in which the borrower records a written promise to repay the lender.

Step 4: Pros of funding sources

Issuing Common Stock: One of the main benefits of issuing common stock is that it reduces the burden of the payment of dividend payment. 

Issuing of Preference Stock: the main benefit of issuing the preferred stock is that in the preferred stock the ownership of the company cannot be transferred.

Issuing Notes: Notes payables are one of the easiest ways to raise funds. Notes payable provide flexibility to purchase the inventory.

Step 5: Option to be opt

Taking money as a note payable is the best option among all because it is easy for the company to raise funds from notes payable as compared to the other funding sources. The notes payable help the company to make delays in the payment of the inventory. This is the reason why notes payable is the best option to raise funds.

 

The cash account is debited by $86,000 and the common stock account is credited by $86,000.