 In this presentation, we will give a preferred stock example. We're going to go through an example of distributing stock and in this example, of course, we have preferred stock and common stock. This is going to be a common book problem type of example and a common problem in practice as well. The only real difficulty here in this type of problem is really setting up a worksheet or a format in order to go through this process. I'm going to point out again that the preferred stock kind of muddies the water and if you think about the setting up of a corporation and many corporations that may not have preferred stock, it's really best to think about it in that format first, meaning the owners have the common stock and that that's going to be broken out between the equity section being broken out between the investment in term of common stock and paid in capital and the retained earnings. We'll throw in the preferred stock here to kind of mix things up a bit and the preferred stock, remember the major benefit of the preferred stock is they're going to get paid before the common stock holder so they don't have the same voting rights in the business but they get paid first and that's why we're saying it's preferred. Now note that it's not preferred in all cases, really the preferred stock are betting on or safeguarding against problems, meaning if the company does well, we probably want the common stock because it's going to benefit us in time as we'll see through this example. If the company runs into problems, then we want the preferred stock because then we get paid first. So paid first is the preferred component, however, the long term how much we get paid if there's growth may be more beneficial for the common stock. As we go through this problem, we'll see the distinction between those two. We're just going to do this in a table format because in order to see this, we want to see what happens over time, over year to year. So we're not going to record the journal entries here, we're just going to say here's going to be the distributions in year one, here's the distributions in year two, who gets the money, who's better off. So here's what we got. We've got year one, board of directors clears a $6,000 dividend. So we'll say, okay, who gets the dividend year two. The board of directors is going to declare a $40,000 dividend. The common stock has a par value of $50 and shares outstanding are $4,000. The preferred stock, we have the dividend rate 10%, the par value 110, the shares $1,000. That's going to be the information. So note what the board of directors can do. The board of directors are the ones that decide whether or not there's going to be a dividend. They can decide not to give a dividend. They can decide to give pretty much whatever dividend amount they want as long as it applies. They can't do so. There's restrictions like how much is in retained earnings and do we have any cash. Other than that, they can kind of decide what the dividend will be and they could decide not to give a dividend. If they, once they decide and note what influence they have, the board of directors being in place by being voted on through the stockholders. So the common stockholders have some influence over the board of directors and therefore indirect influence over the dividend would be declared through their voting power unlike the preferred shareholders. Once the board of directors decides to give a dividend, what they cannot do is decide that this particular shareholder gets more of the dividend than somebody else. Can't do that. They all have to be the same and what they cannot do typically is pay the common shareholders before the preferred shareholders. So note that the common shareholders have voting right. They have influence over the board of directors who makes the dividend amount. But the preferred shareholders, because they're preferred, have the right to be paid first. That's what it means to be a preferred shareholder. So let's go through the scenario. If the board of directors decides, okay, we're going to pay a $6,000 dividend, they can decide that. They don't get to decide who it goes to. It goes to whoever it goes to in a set of rules. So first it's going to go, this is the dividend declared, $6,000. And this is how you want to set up the table, really. You've got the preferred, I usually calculate the full dividend and then the amount that will be allocated to the preferred stock and then the amount that is in arrears that hasn't been allocated that's still due and then the common stock. So this will make sense as we go through, $6,000 dividend. Now the preferred stock, full dividend would be $11,000. How do you calculate that? You just take, you'll have a dividend rate for the preferred stock. We'll take the par value and the number of shares and just multiply those out. So we've got the shares are $1,000. The par value is $110 times $110. That gives us $110,000. We're just going to take that times the 10%, the dividend rate and that's the $11,000. So in other words, if all else equal whatever the board of directors declared, if it's greater than $11,000, then, and this, you can think of this as like an if then formula in Excel or if it's greater than $11,000 that they declare, then they get $11,000 or if it's equal or greater than $11,000. If it's less than the $11,000, then they get whatever is declared. In this case, it's less than the $11,000, so they're going to get the $6,000. In other words, they get all of it. They get the full thing, meaning the common stock is going to get nothing. Not only that, but typically they get the dividends in arrears, which just basically means that they're going to accumulate upwards the amount that is owed to them. So in other words, the board of directors can decide not to pay them the full $11,000, but what they can't do is pay the common stockholders until they pay off the full amount at some point in the future. So the common stockholders are held hostage. They're not going to get anything until we pay off all the dividends in arrears and current dividends. So the common stockholders for year one get zero. So in this scenario, when the dividends are low, the preferred stockholder is clearly the advantage spot here because they're getting paid and the common stockholders getting nothing. But what if the company does very well over time? Then you have a higher dividend, so if dividends like $40,000 because the company is doing quite well, then you're going to say, well, the full dividend is $40,000. The amount going to the preferred stockholder is the same, $11,000, same calculation, $1,000 shares times the par value, $110 times the dividend rate, $10%. And that means that how much are they going to get paid? They're going to, for the preferred, they're going to get that $11,000 plus the dividend in arrears or $16,000. So we've paid off all these, so these have been paid off and we paid off the current amount in year two for the full $16,000. Common stock then gets the $40,000 minus the $16,000. So the common stock is getting the $40,000 minus $16,000 minus the $16,000 or the $24,000. So you can see that the common stock amount is going up as the dividends go up. Now again, you got to say, well, how many shares are out there, $4,000? So you can calculate the amount that's going to get paid per share, the $24,000 divided by four. But just note that these type of problems will typically look like this, will typically show in the beginning that the amount of dividend declared will not be over the amount that's going to be paid to the preferred stock, which clearly is making the preferred stock better off. And then as time passes, if the company does well, the common stockholder is really betting on long-term growth, their amount will go up. Like if we paid another $40,000 in the following year, or say $45,000 if it went up, the preferred stock would only be $11,000 here still. And they wouldn't have any arrears, so it would just be $11,000 that they get and they would be stuck at that $11,000 all the way down. If we had $40,000 next year, $50,000 and the business starts to really do well, then these will stay static and the common stock amounts will go up. So just remember the preferred stock is not the norm when you think about the ownership. You really, the norm is the common stock because they have the voting rights. Preferred stock is preferred because they get paid first and really it's hedging the bets to be on a more conservative side to bet against something bad happening, such as the dividends being below what is being stated or the company liquidating and going out of business in which case they get paid first. But it's not as geared towards the long-term growth as the common stock, which would be continually increasing in terms of the value that their stock would be as well as the value of the dividends if the amount of dividends declared goes up over time.