In this and the next episode, we will talk about shareholder's equity. While strictly speaking for us the students of value in general, we should just have an idea of how accounting recording for shareholders equity happens. Because we care much more about the market value rather than any book value. You remember that the book value of stock only goes into a various procedure when we talked about these black boxes via cash generating power. Now, another problem is that unfortunately or fortunately, that's up to you, the idea of par value for stock has little value, has little meaning, if you will. Sometimes stocks are issued at a stated value of no par, but most often they do have some par value that plays just illegal roles, so you can not sell the stock below this par value. But again, by far the prevalent concept for the stock is the market value. So let's recall something. That'll be shareholder's equity Part 1. So we remember that in general, so this is balance sheets, so these are the assets, liabilities, and net worth. So this is equity. So this is the source of financing that is put up by the owners of the company. Now, for understanding and for some accounting purposes, we have to say that this is broken down in various categories. So let me put types of equities, I will put the types quoted. So you've heard about that, so we have preferred stock, we have common stock, we have additional paid in capital, and, I'll use a different color, we have retained earnings. So basically, you issue stock, preferred or common. If you issue that at par, then additional paid-in capital is the difference between the issue price and par, and then retained earnings is that what we made over this period of time, retained earnings are the only source of cash dividends, for example. Now, let's introduce some of these parameters, like I said, par value. I'll put legal, literal meaning. But it's used to to break down your precedes between common started initial paid-in capital. So let's say that we issue stock, and I will show some transactions here, and for the purpose of an example would say 5,000 shares, and then par $10 but the issue price $25. See what happens. So we have the following: so we have cash, we have common stock, and we have additional paid-in capital. see what happens. We issued stock 5,000 shares at a price of 25, that makes it $125,000, of which this part goes. So cash is 125. But we put 50,000 here as common stock and then 75 goes in here as additional paid-in capital. Like I said, this is the difference between the par value of the stock and the issue price. Again, not that much meaning but we have to keep this in mind. Now, in what follows I will say a few more words about preferred stock. Now this is a special kind of stock, and the main idea here is that the owners of preferred stock they do not have the right to vote, but they have privileges with respect to dividend receipts. Well, that's oftentimes leads to a conflict between common shareholders and preferred shareholders. We'll discuss that in greater detail later in our fourth course on other days at the close to the end, and we talk about corporate governance, then we'll see that sometimes if preferred stock is not structured properly, that may produce this conflict of interest and play a detrimental role. But for now, we first of all say that preferred stock is preferred with respect to dividends. So it's all those other first in line ahead of common shareholders. Again, here there are two points; this is cumulative and sometimes also participating or participate or maybe both. Then also what we know about preferred stock that it has no voting power, that is very important, and also there's special provisions. It may be callable from the company issue, it may be convertible into common and this is also the option for the holder, and it may be redeemable, this is the option for the issuer company. Again, specifics will postpone. Let me give you some example of what happens with the accounts. Let's say if preferred stock is five percent and it's cumulative, and it's $10 par and then there are 1,000 shares. Now I will show how what is cumulative. The idea is as follows; if a company for any reason, does not pay a dividend this year. Then still part of this dividend accrues to the holders of preferred stock. So if the next year the company still does pay dividends, so more accrues, and more the company does declare a dividend. First, it has to pay to the owners of cumulative preferred stock all the dividends in arrears. So for previous year, for the other, let's say, the year before previous, and so on, I'll give you an example and that becomes crystal clear. So cumulative preferred stock. So here we have year 1, no dividends, year 2 no dividend, finally in year 3, there is some dividend declared. See what happens. If it's a five percent, so we expect to receive here $500, here also $500, so not that we expect, we must receive that at the moment, and the company does declare a dividend, and by the same token here. So in year 3, we should receive here $1,500. If there's anything left, that can go to some other shareholders. But for the owners of cumulative preferred stock, first of all you have to redeem these obligations and pay them this 1,500. Now, to complete the story, the preferred stock may be cumulative and participating. Again, it participates in what is left after company redeemed all the obligations with respect to the cumulative feature. If it's both, so the owners of this preferred stock, they enjoy the privilege of cumulative and then the privilege of participating. I'll give you an example right now. So this is participating in what's left. Let's say that in the good third-year, the total is $3,500 to deepen it out. So we know that from this amount, 1,500 goes right away to the owners of cumulative preferred stock. Now what's left? Left is $2,000. Then for example, if there is the cumulative and participating, so they first as cumulative receive this and then as participating, C plus PS. They can get from this amount 500 more. That's just for illustrative purposes. So cumulative and participating, they received a total of 2,000. All of the remaining 1,500, that may go to common shareholders. Now, most often, the actual numbers are somewhat more cumbersome, but the idea is here. That is why oftentimes the people use investments in preferred stock, we are talking about the people who buy the stocks and who provide cash for the company. Just keep in mind that their ability to collect dividends is privileged, and that also influences the evaluation of preferred stock. So here I am taking a pause, and in the next episode, I will add some more special features of Accounting, the shareholders equity, and then we'll be [inaudible] all set.
