White:I’ve been thinking about that. What if we promise the investors that we will pay them
2% of net sales until they have received an amount equal to what they paid for the stock?
Klein:What happens when we pay back the $20 million? Do the investors get to keep the
stock? If they do, it’ll dilute our ownership.
White:How about, if after we pay back the $20 million, we make them turn in their stock for
$100 per share? That’s twice what they paid for it, plus they would have already gotten
all their money back. That’s a $100 profit per share for the investors.
Klein:It could work. We get our money, but don’t have to pay any interest, dividends, or the
$100 until we start generating net sales. At the same time, the investors could get their
money back plus $100 per share.
White:We’ll need current financial statements for the new investors. I’ll get our accountant
working on them and contact our attorney to draw up a legally binding contract for the
new investors. Yes, this could work.In late 2007, the attorney and the various regulatory authorities approved the new stock of-
fering, and 400,000 shares of common stock were privately sold to new investors at the stock’s
par of $50.
In preparing financial statements for 2007, Donna White and Anita Sparks, the controller
for Kilimanjaro Inc., have the following conversation.Sparks:Donna, I’ve got a problem.
White:What’s that, Anita?
Sparks:Issuing common stock to raise that additional $20 million was a great idea. But...
White:But what?
Sparks:I’ve got to prepare the 2007 annual financial statements, and I am not sure how to clas-
sify the common stock.
White:What do you mean? It’s common stock.
Sparks:I’m not so sure. I called the auditor and explained how we are contractually obligated
to pay the new stockholders 2% of net sales until $50 per share is paid. Then, we may be
obligated to pay them $100 per share.
White:So...
Sparks:So the auditor thinks that we should classify the additional issuance of $20 million as
debt, not stock! And, if we put the $20 million on the balance sheet as debt, we will vio-
late our other loan agreements with the banks. And, if these agreements are violated, the
banks may call in all our debt immediately. If they do that, we are in deep trouble. We’ll
probably have to file for bankruptcy. We just don’t have the cash to pay off the banks.- Discuss the arguments for and against classifying the issuance of the $20 million of stock as
debt. - What do you think might be a practical solution to this classification problem?
Matterhorn Inc. has paid quarterly cash dividends since 1993. These dividends have steadily in-
creased from $0.05 per share to the latest dividend declaration of $0.40 per share. The board of
directors would like to continue this trend and is hesitant to suspend or decrease the amount of
quarterly dividends. Unfortunately, sales dropped sharply in the fourth quarter of 2007 because
of worsening economic conditions and increased competition. As a result, the board is uncertain
as to whether it should declare a dividend for the last quarter of 2007.
On November 1, 2007, Matterhorn Inc. borrowed $400,000 from Cheyenne National Bank to
use in modernizing its retail stores and to expand its product line in reaction to its competition.
The terms of the 10-year, 12% loan require Matterhorn Inc. to:a. Pay monthly interest on the last day of the month.
b. Pay $40,000 of the principal each November 1, beginning in 2008.
c. Maintain a current ratio (current assets ÷ current liabilities) of 2.
d. Maintain a minimum balance (a compensating balance) of $20,000 in its Cheyenne
National Bank account.On December 31, 2007, $100,000 of the $400,000 loan had been disbursed in modernization
of the retail stores and in expansion of the product line. Matterhorn Inc.’s balance sheet as of
December 31, 2007, is as follows:532 Chapter 11 Stockholders’ Equity: Capital Stock and Dividends
Activity 11-5
Dividends