Financing Activities: Contributed and Earned Capital

1. Financing Activities:Contributed and Earned Capital Shareholders’ Equity: Common Stock Other Paid-in Capital Retained Earnings

2. Stockholders’ Equity • Growth in Stockholders’ equity • Owners contribute capital (buy stock) • Operations are profitable (net income / retained earnings) • Reduction in Stockholders’ equity • Net loss • Pay dividends • Buy back shares • Buy treasury stock

3. Target Corp. Stockholders Equity at January 31, 2009 and January 31, 2008 Shareholders’ investment (in US $millions): Common stock 63 68 Additional paid-in-capital 2,762 2,656 Retained earnings 11,443 12,761 Accumulated other comprehensive loss (556) (178) Total shareholders’ investment 13,712 15,307 Total liabilities and shareholders’ investment $44,106 $44,560 Common Stock Authorized 6,000,000,000 shares, $.0833 par value; 752,712,464 shares issued and outstanding at January 31, 2009; 818,737,715 shares issued and outstanding at February 2, 2008 Preferred Stock Authorized 5,000,000 shares, $.01 par value; no shares were issued or outstanding at January 31, 2009 or February 2, 2008

4. Stockholders’ Equity Section of the Balance Sheet Contributed Capital: Common stock Paid-in capital in excess of par Earned Capital: Retained earnings Other: Other comprehensive income

5. Contributed Capital: Offering of Shares • Shares of common stock represent ownership in the entity • Shareholders make a capital contribution to the company • The amounts contributed are recorded in contributed capital accounts • Common stock (at par) • Paid in capital in excess of par • Status of common shares • Authorized • Issued • Outstanding • (In treasury)

6. Issuing Common Stock Standard Company has 1,000,000 shares of common stock authorized with a par value of $1 per share, of which 500,000 shares are outstanding. The company received $10 per share when it issued shares to the public. Required: What is the book value of the common stock par account and the paid-in capital in excess of par (additional paid-in capital) account?

7. Solution: Contributed Capital Illustration |Cash 5,000,000 | Common stock 500,000 | Paid in capital in excess of par 4,500,000 Contributed Capital: Common stock, $1 par, 1,000,000 shares authorized, 500,000 shares issued and outstanding $ 500,000 Paid in capital in excess of par 4,500,000

8. How Many Shares? Mann Corporation’s accounting records included the following stockholders’ equity accounts: Preferred stock, $1 par value, 20,000 sharesauthorized $10,000 Additional paid-in capital – preferred stock $90,000 Common stock, $1 par value, 500,000 shares authorized $100,000 Paid-in capital in excess of par – common stock $900,000 Required: How many shares of preferred stock and how many shares of common stock have been issued?

9. Stockholders’ Equity After a Stock Repurchase Why do companies buy back shares of the company’s stock? • Acquire shares to give to employees when they exercise stock options • Perceive shares to be undervalued • Company has excess cash to distribute to shareholders • Alternative to dividends • Don’t want to be “bound” to an annual dividend payment • Shareholders that sell their shares taxed at lower marginal capital gains rate • Shareholders that do not want to sell shares • Do not have tax liability “forced” upon them • Increase their ownership percentage

11. Accounting for Share Repurchases • Equity reduced by share buyback • Treasury stock is a contra-shareholders’ equity account • No gains or losses from transactions in shares of the company’s own stock • If treasury shares are reissued for more (less) than reacquisition cost • A contributed capital accounting is increased (decreased) rather than a gain (loss) account

12. Illustration – Share Repurchases Parktown Corp. was organized on January 1, 2000. On that date, the company issued 200,000 shares of its $10 par value common stock for $15 per share (400,000 shares were authorized). During the period from January 1, 2000 through December 31, 2010, Parktown reported net income of $1,000,000 and paid cash dividends of $200,000. On January 5, 2009, Parktown purchased 10,000 shares of its common stock (treasury stock) for $12 per share. On December 31, 2010, Parktown sold 5,000 treasury shares for $8 per share. Required: What stockholders’ equity amounts will Parktown report on its December 31, 2012 Balance Sheet?

13. Stock Dividends and Stock Splits • Economically the same transaction • Stock splits involve have no dollar impact on the accounts • Stock dividends involve a transfer from retained earnings to contributed capital • Capitalize past earnings • Increase the number of shares • Reduce the per share par value • Reduce the per share market value • Total stockholders’ equity dollars remain the same

14. Stockholders’ Equity After a Stock Split Effective April 27, 2005, the stockholders of Dorr Corporation approved a two-for-one split of the company’s common stock and an increase in authorized common shares from 100,000 shares ($20 par value) to 200,000 shares ($10 par value). The stock split shares were issued on June 30, 2005. Dorr’s stockholders’ equity accounts immediately before issuance of the stock split were: Common stock, par value $20; 100,000 shares authorized; 50,000 shares outstanding $1,000,000 Additional paid-in capital $150,000 Retained earnings $1,350,000 Dorr’s stock price on the NYSE closed at $100 per share the night before the split shares were issued.

15. Stock Split illustration (Continued) Required: After issuing the stock split shares • What is the number of shares authorized? • What is the number of shares outstanding? • What is the par value of each share? • What is the dollar value of the Common Stock account as shown on the Balance Sheet (at par)? • What is the Additional Paid-in Capital balance? • What was the market capitalization of the company before the stock split? • What is the theoretical stock price (and market cap) when shares opened for trading June 30, 2005 assuming no other value relevant news?

16. Earned Capital • Earned capital (net income) is closed to the retained earnings account each period • Retained earnings is the sum of earned and retained capital to date • Net income Less Dividends • Stock dividends also create a transfer from the earned capital to the contributed capital accounts

17. Other Comprehensive Income • Unrealized gains (losses) that are reflected in net equity but have not yet been reflected in income • Gains (losses) coming to a future income statement • Will ultimately transfer from OCI to retained earnings • Result from various transactions • Gains (losses) on available for sale securities • Gains (losses) on certain derivatives • Cash flow hedges • Certain foreign currency translation gains (losses) • Minimum pension liability adjustments

18. Earnings Per Share • Earnings per common share • Required disclosure on the face of the income statement • Highly correlated with stock price • If you can predict increases (decreases) in earnings per share • On average, you can predict the direction of stock price changes • Key measure of relative stock price • P/E ratio

19. Earnings Per Share (EPS) and Simple Capital Structure • Simple capital structure • No potentially dilutive securities in capital structure • Securities that can be converted to common stock and dilute EPS • Stock options, warrants, rights • Convertible bonds or convertible preferred stock • Subscribed stock, contingently issuable shares, other • Single EPS reported EPS = [Net income available to common shareholders / Weighted average number of common shares outstanding]

20. EPS and Complex Capital Structure • Complex capital structure has potentially dilutive securities • Dual EPS presented • Basic and Diluted EPS • Diluted EPS is EPS adjusted for potentially issuable sharescurrently held by third parties • The “E” in P/E ratio is diluted earnings per share for companies with a complex capital structure

21. Target Corp. EPS Net earnings $ 2,214 $ 2,849 $ 2,787 Basic earnings per share $ 2.87 $ 3.37 $ 3.23 Diluted earnings per share $ 2.86 $ 3.33 $ 3.21 Weighted average common shares outstanding Basic 770.4 845.4 861.9 Diluted 773.6 850.8 868.6

22. Illustration: EPS The Stream Company’s net income for the year ending December 31, 2010 was $105,000. During the year, Stream declared and paid $5,000 cash dividends on preferred shares and $30,000 cash dividends on common shares. At December 31, 2010, the company had 100,000 shares of common stock issued and outstanding – 50,000 had been issued and outstanding throughout the year and 50,000 were issued on July 1, 2010. There were no other common stock transactions during the year, and the 5,000 shares of preferred stock are not convertible into common shares. Required: What EPS will Stream Company report for 2010?

23. Earnings Per Share: Complex Capital Structure Information concerning the capital structure of the Peters Corporation is as follows: December 31 20092010 Common stock in shares 100,000 100,000 Preferred stock in shares 10,000 10,000 8% convertible bonds $1,000,000 $1,000,000 During 2010, Peters paid dividends of $1 per share on its common stock and $2.00 per share on its preferred stock. The preferred shares are convertible into 20,000 shares of common stock. The 8% convertible bonds are convertible into 40,000 shares of common stock. The net income for the year ending December 31, 2010 was $400,000, and the company’s income tax rate is 40%. In addition, company employees hold options to purchase 10,000 shares. The incremental dilution of these options (under the Treasury Stock Method) is 5,000 shares. Required: Determine the amounts of Peters Corp.’s dual EPS disclosure for 2010.

24. Recorded Equity Values versus Market Equity Values Target Express Scripts 1/31/09 12/31/08 (In US $millions) Book value of equity $13,712 $1,078.2 Market value of equity $23,485 $13,616 Market / Book 1.71 12.6