Question

Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant.

A). Explain Dividends, total assets, EBIT and new common stock.

B).What affect will it  have on the company’s financial statements and which accounts would be impacted ? Explain in detail (min 400 words)

Answer 1

A) Cash Dividends

Cash dividends are a distribution of a corporation's earnings to its stockholders or shareholders. For cash dividends to occur, the corporation's board of directors must declare the dividends.

Examples of How Cash Dividends Affect the Financial Statements

When a corporation's board of directors declares a cash dividend on its stock, the following will occur:

• Retained earnings (a part of stockholders' equity) will decrease
• Current liabilities (such as Dividends Payable) will increase

When the cash dividend is paid, the following will occur:

• Current liabilities (Dividends Payable) will decrease
• Current assets (Cash) will decrease

The income statement is not affected by the declaration and payment of cash dividends on common stock.

It includes include:

• Cash – this is the payment of actual cash from the company directly to the shareholders and is the most common type of payment. The payment is usually made electronically (wire transfer), but may also be paid by check or cash.
• Stock – stock dividends are paid out to shareholders by issuing new shares in the company. These are paid out pro rata, based on the number of shares the investor owns.
• Assets – a company is not limited to paying distributions to its shareholders in the form of cash or shares. A company may also pay out other assets such as investment securities, physical assets, real estate, and others.
• Special – a special dividend is one that’s paid outside of a company regular policy (i.e., quarterly, annual, etc.). It is usually the result of an excess cash build up.
• Common – this refers to the class of shareholders (i.e., common shareholders), not what’s actually being received as payment.
• Preferred – this also refers to the class of shareholder receiving the payment.
• Other – other, less common, types of financial assets can be paid out such as options, warrants, shares in a new spin-out company, etc.

EBIT

Investors and creditors use EBIT because it allows them to look at how successful the core operations of the company are without having to worry about the tax ramifications or the cost of the capital structure. They can simply look at whether the business activities and ideas behind them actually work in the real world. For instance, they can look at a manufacturer of stuffed animals to see if it is actually making money producing each animal without regard to the cost of the manufacturing plant. Examining the operations in this way helps investors understand a company’s health and ability to pay it debt obligations.

EBIT = Total Revenue – COGS – Operating Expenses

EBIT = Net Income + Interest + Taxes

Total assets refer to the total amount of assets owned by a person or entity. Assets are items of economic value, which are expended over time to yield a benefit for the owner. If the owner is a business, these assets are usually recorded in the accounting records and appear in the balance sheet of the business

Common stock is a security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are at the bottom of the priority ladder in terms of ownership structure; in the event of liquidation, common shareholders have rights to a company's assets only after bondholders, preferred shareholders and other debtholders are paid in full.

B) The company's net income would increase.

According to the problem the company just change their capital structure from debt to equity . means they raise equity to pay debt.

The Assets remain unchanged but equity section is increased and decrease in liability.

The impact of issuing Equity the EPS will decrease per share because no. of share will increase to divide net profit after preferred dividend (If any )

The Company net profit decrease too because on debt interest payment company can take tax benefits.

So the net impact is In income statement Net profit is decrease.

In balance sheet Equity increase , Debt decrease and also retained earning decrease and cash will decrease too.