Thomas is nearing retirement and would like to invest in a stock that will provide a good steady income. Thomas should choose a stock with a

Practice Multiple-Choice Questions

1. (LO 1) Which of these is not a major advantage of a corporation?

  1. Separate legal existence.
  2. Continuous life.
  3. Government regulations.
  4. Transferable ownership rights.

2. (LO 1) A major disadvantage of a corporation is:

  1. limited liability of stockholders.
  2. additional taxes.
  3. transferable ownership rights.
  4. None of the above.

3. (LO 1) Which of these statements is false?

  1. Ownership of common stock gives the owner a voting right.
  2. The stockholders’ equity section begins with paid-in capital.
  3. The authorization of capital stock does not result in a formal accounting entry.
  4. Legal capital is intended to protect stockholders.

4. (LO 2) ABC Corp. issues 1,000 shares of $10 par value common stock at $12 per share. When the transaction is recorded, credits are made to:

  1. Common Stock $10,000 and Paid-in Capital in Excess of Stated Value $2,000.
  2. Common Stock $12,000.
  3. Common Stock $10,000 and Paid-in Capital in Excess of Par Value $2,000.
  4. Common Stock $10,000 and Retained Earnings $2,000.

5. (LO 2) Treasury stock may be repurchased:

  1. to reissue the shares to officers and employees under bonus and stock compensation plans.
  2. to signal to the stock market that management believes the stock is underpriced.
  3. to have additional shares available for use in the acquisition of other companies.
  4. More than one of the above.

6. (LO 3) Preferred stock may have priority over common stock except in:

  1. dividend preference.
  2. preference to assets in the event of liquidation.
  3. cumulative dividends.
  4. voting.

7. (LO 3) U-Bet Corporation has 10,000 shares of 8%, $100 par value, cumulative preferred stock outstanding at December 31, 2022. No dividends were declared in 2020 or 2021. If U-Bet wants to pay $375,000 of dividends in 2022, common stockholders will receive:

  1. $0.
  2. $295,000.
  3. $215,000.
  4. $135,000.

8. (LO 3) Entries for cash dividends are required on the:

  1. declaration date and the record date.
  2. record date and the payment date.
  3. declaration date, record date, and payment date.
  4. declaration date and the payment date.

9. (LO 3) Which of these statements about stock dividends is true?

  1. Stock dividends reduce a company’s cash balance.
  2. A stock dividend has no effect on total stockholders’ equity.
  3. A stock dividend decreases total stockholders’ equity.
  4. A stock dividend ordinarily will increase total stockholders’ equity.

10. (LO 3) Zealot Inc. has retained earnings of $500,000 and total stockholders’ equity of $2,000,000. It has 100,000 shares of $8 par value common stock outstanding, which is currently selling for $30 per share. If Zealot declares a 10% stock dividend on its common stock:

  1. net income will decrease by $80,000.
  2. retained earnings will decrease by $80,000 and total stockholders’ equity will increase by $80,000.
  3. retained earnings will decrease by $300,000 and total stockholders’ equity will increase by $300,000.
  4. retained earnings will decrease by $300,000 and total paid-in capital will increase by $300,000.

11. (LO 4) In the stockholders’ equity section of the balance sheet, common stock:

  1. is listed before preferred stock.
  2. is added to total capital stock.
  3. is part of paid-in capital.
  4. is part of additional paid-in capital.

12. (LO 4) In the stockholders’ equity section, the cost of treasury stock is deducted from:

  1. total paid-in capital and retained earnings.
  2. retained earnings.
  3. total stockholders’ equity.
  4. common stock in paid-in capital.

13. (LO 4) The return on common stockholders’ equity is usually increased by all of the following, except:

  1. an increase in the return on assets ratio.
  2. an increase in the use of debt financing.
  3. an increase in the company’s stock price.
  4. an increase in the company’s net income.

14. (LO 4) Thomas is nearing retirement and would like to invest in a stock that will provide a good steady income. Thomas should choose a stock with a:

  1. high current ratio.
  2. high dividend payout.
  3. high earnings per share.
  4. high price-earnings ratio.

15. (LO 4) Jackson Inc. reported net income of $186,000 during 2022 and paid dividends of $26,000 on common stock. It also paid dividends on its 10,000 shares of 6%, $100 par value, noncumulative preferred stock. Common stockholders’ equity was $1,200,000 on January 1, 2022, and $1,600,000 on December 31, 2022. The company’s return on common stockholders’ equity for 2022 is:

  1. 10.0%.
  2. 9.0%.
  3. 7.1%.
  4. 13.3%.

16. (LO 4) If everything else is held constant, earnings per share is increased by:

  1. the payment of a cash dividend to common shareholders.
  2. the payment of a cash dividend to preferred shareholders.
  3. the issuance of new shares of common stock.
  4. the purchase of treasury stock.

Solutions

1. c. Government regulations are a disadvantage of a corporation. The other choices are advantages of a corporation.

2. b. Additional taxes are a disadvantage of a corporation. The other choices are advantages of a corporation.

3. d. Legal capital is intended to protect creditors, not stockholders. The other choices are true statements.

4. c. Common Stock should be credited for $10,000 and Paid-in Capital in Excess of Par Value should be credited for $2,000. The stock is par value stock, not stated value stock, and this excess is contributed, not earned, capital. The other choices are therefore incorrect.

5. d. Treasury stock may be repurchased to reissue the shares as part of bonus and stock compensation plans, to signal to the stock market that the stock is underpriced, and to have additional shares available for use in the acquisition of other companies. Choice (a), (b), (c) are all correct, but (d) is the best answer.

6. d. Preferred stock usually does not have voting rights and therefore does not have priority over common stock on this issue. The other choices are true statements.

7. d. The preferred stockholders will receive a total of $240,000 of dividends [dividends in arrears ($80,000 × 2 years) + current-year dividends ($80,000)]. If U-Bet wants to pay a total of $375,000 in 2022, then common stockholders will receive $135,000 ($375,000 − $240,000), not (a) $0, (b) $295,000, or (c) $215,000.

8. d. Entries are required for dividends on the declaration date and the payment date, but not the record date. The other choices are therefore incorrect.

9. b. A stock dividend moves amounts from retained earnings to paid-in capital and has no effect on stockholders’ equity or cash. The other choices are therefore incorrect.

10. d. A 10% stock dividend on the company’s common stock will increase the number of shares issued by 10,000 (100,000 × 10%). At a market price of $30 per share, total paid-in capital will increase by $300,000 (10,000 shares × $30/share) and retained earnings will decrease by that same amount. The other choices are therefore incorrect.

11. c. Common stock is part of paid-in capital. The other choices are incorrect because common stock (a) is listed after preferred stock, (b) is not added to total capital stock but is part of capital stock, and (d) is part of capital stock, not additional paid-in capital.

12. a. The cost of treasury stock is deducted from total paid-in capital and retained earnings. The other choices are therefore incorrect.

13. c. An increase in the company’s stock price has no effect on the return on common stockholders’ equity. The other choices are incorrect because (a) an increase in a firm’s return on assets, (b) an increase in a firm’s use of debt financing, and (c) an increase in a firm’s net income will all increase the return on common stockholders’ equity.

14. b. Thomas should focus on a high dividend payout. The other choices are incorrect because a stock with a (a) high current ratio, (c) high earnings per share, or (d) high price-earnings ratio may or may not pay dividends on a consistent basis.

15. b. Return on common stockholders’ equity is net income available to common stockholders divided by average common stockholders’ equity. Net income available to common stockholders is net income less preferred dividends = $126,000 [$186,000 − (10,000 × .06 × $100)]. The company’s return on common stockholders’ equity for the year is therefore 9.0% [$126,000/($1,200,000 + $1,600,000)/2)], not (a) 10.0%, (c) 7.1%, or (d) 13.3%.

16. d. The purchase of treasury stock reduces the number of shares outstanding, which is the denominator of earnings per share (EPS). With a smaller denominator, EPS is larger. The other choices are incorrect because (a) the payment of a cash dividend to common stockholders does not affect the earnings or the number of outstanding shares, so EPS will stay the same; (b) the payment of a cash dividend to preferred stockholders will reduce the amount of earnings available to the common stockholders, thus reducing EPS; and (c) the issuance of new shares of common stock would not affect earnings but will increase the number of outstanding shares, thereby reducing EPS.