Question

1. Ulrich Inc. just announced the quarterly earnings report for its fiscal second quarter and a quarterly dividend. The net income for the second quarter was $650,000, of which 30% will be paid as dividends. The balance sheet at the end of the fiscal first quarter had a retained earnings balance of $3,545,000. Calculate the retained earnings that will be shown on the balance sheet at the end of Ulrich's fiscal second quarter.

2. Ulrich Inc.'s articles of incorporation authorize the firm to issue 500,000 shares of $5 par value common stock, of which 410,000 shares have been issued by the company. What is the total dedicated capital (i.e., total par value of common equity) on the firm's balance sheet?

3. Bond prices decline as interest rates increase. This is called bond interest rate risk. The amount of interest rate risk depends on what particular features of a bond?

Answer 1

1) 2nd Quarter Earnings = 650,000

Dividend Payout Ratio = 30%

1st Quarter Retained Earnings = 3,545,000

Dividend to be Paid in 2nd Quarter = Second Quarter Earnings * Dividend Payout Ratio

Dividend to be Paid in 2nd Quarter = 650,000 * 30% = 195,000

Addition to Retained Earnings in 2nd Quarter = Second Quarter Earnings - Dividend to be Paid in Second Quarter

Addition to Retained Earnings in 2nd Quarter = 650,000 - 195,000 = 455,000

Retained Earnings at the end of 2nd quarter = 1st Quarter Retained Earnings + Addition to Retained Earnings in 2nd Quarter

Retained Earnings at the end of 2nd quarter = 3,545,000 + 455,000 = 4,000,000

Hence, Retained Earnings at the end of 2nd quarter is $ 4,000,000 or $ 4 million.

2) Number of shares authorized = 500,000

Par Value = $ 5 per share

Number of shares issued = 410,000

Total Dedicated Capital or Total Par Value of Common Equity = Number of shares issued * Par value per share

Total Dedicated Capital = 410,000 * 5 = $ 2,050,000

Hence, Total Dedicated Capital or Total Par Value of Common Equity of the company is $ 2,050,000

3) As interest rate increases, bond prices decrease because they have an inverse relation primarily due to effect on the yield from the Face value or Principal to be received at the maturity of the bond. If an investor buys the bond at higher price than par value, then his yield would be lower compared to investor who bought the bond lower price than par value.

The Interest rate risk of a bond depends on the duration of a bond. Longer the maturity of bond, higher the interest rate risk it faces because in time value money, cashflows further in time are charged higher premium using a discount rate than cashflows in near future. Moreover, due to uncertainty, farther the cashflows are in future, higher is the risk of borrower's default which leads to higher interest rate risk.