Question

A company has outstanding 10 million shares of $2 par common stock and 1 million shares of $4 par preferred stock. The preferred stock has an 8% dividend rate. The board of directors declares $300,000 in total dividends for the year. Which of the following is correct if the preferred stockholders have a cumulative dividend preference?
A. Preferred stockholders will receive the entire $300,000 and they must also be paid $20,000 before the end of the current accounting period; common stockholders will receive nothing.
B. Preferred stockholders will receive $24.000 (or 8% of the total dividends); common stockholders will receive the remaining $276.000 (or $300,000 $24,000).
C. Preferred stockholders will receive the entire $300,000 and they must also be paid the remaining $20,000 sometime in the future before common stockholders will receive any dividends.
C. Preferred stockholders will receive the entire $300,000, but will receive nothing more in the future relating to this dividend declaration; common stockholders will receive nothing.

Answer 1

Answer:

C. Preferred stockholders will receive the entire $300,000 and they must also be paid the remaining $20,000 sometime in the future before common stockholders will receive any dividends.

Explanation:

Preferred shares have preference over the common shares in respect of dividend. Since $300,000 is paid as dividend, the entire amount has to be paid to the preferred shareholders, as the total amount payable to them as dividend = $1,000,000 * 4 *8% = $320,000, which is more than the total dividend declared.

In addition, as the preferred shares have cumulative dividend preference the shortfall in any year is to be carried forward and paid in the year in which dividends are paid and that too before any dividend is paid to the common shareholders.