Question

Larkspur Inc. had 506,000 common shares outstanding for the entire fiscal year ended August 31, 2020. Larkspur has 110,000outstanding $2 cumulative, no-par value preferred shares. All shares were outstanding for the full year. Options were written at the start of the fiscal year to purchase 32,000 common shares at $17 per share. The average market price of Larkspur’s common shares during the year ended August 31, 2020 was $25 per share. The options expire in 2029, and none were actually exercised during the current year. Also outstanding for the entire year was a 8% bond with a face value of $6,160,000, convertible to 145,600 common shares. Larkspur Inc.’s net income for the year was $2,699,400, and the income tax rate for the fiscal year was 40%. (For simplicity, ignore the requirement to record the debt and equity portions of the convertible bond separately).

Calculate the income effect of the dividends on preferred shares.

Dividends on preferred shares =

Answer 1

Explanation:

(1)

Preference shareholders have a claim over dividend payable to them i.e. preference shareholders have a right to receive dividend when the company makes profit and management have no say in the same. Therefore, the dividend payable to preference shareholders is deducted from the net profit to calculate net profit available to equity shareholders. Here,

Net profit available to Equity Shareholders = Net Profit - Dividend paid to Preference Shares

                                                                                   = $2,699,400 - ($2*110,000)

                                                                                   = $2,479,400

Divident Paid on preferred shares = $2 × 110,000 = $220,000