Hello everyone. In today's example, I want to focus on the distribution of dividends between common stockholders versus preferred stockholders. This actually depends severely on the terms of the preferred stock. We know that the preferred stock will have priority, so obviously, will be paid off dividends before the common stockholders. But there are some features that will give and add some complications or additional steps for the process of allocating the dividends among the common stockholders and preferred stockholders. Like preferred stock that has a feature of being cumulative or participating. We will take those features in details and see how when it is cumulative. Cumulative means that actually what I have not paid on earlier years will accumulate in what we call dividends in arrears. When you start paying dividends, you have to pay whatever dividends and arrears that you didn't pay for the years before, before you pay this year's dividends. Actually, all that has to be paid before you pay any something to the common stockholders. Participating means that after I allocate an equivalent percentage to the common stockholders, equivalent to what I allocate it to the preferred, the preferred stockholders will actually participate some way or another in the remaining dividends. It does not all go to the common stockholders. Let's take a look. Here you go. Universal incorporation has 600,000 of eight percent preferred stock and 900,000 of common stock outstanding. Obviously, the eight percent was determined to the preferred, but there's no percentage per determined to the common stockholders. Both of them have apparent value of $10 per share, but that is a total dollar value. No dividends have been paid or declared during 2018 and 2019. As of December 31st, 2020, it is desired to distribute 306,000 in dividends. Let's see how we are going to allocate that $306,000 among preferred first and then common in four different scenarios. The preferred is noncumulative and nonparticipating. Actually, when it's noncumulative then the dividends that were not paid in 2018 and 2019 are gone because if it's noncumulative then I did not generate that dividends in arrears. Letter b requirement, the preferred is cumulative and nonparticipating. Letter c, the preferred is cumulative and fully participating. In letter d, the last requirement, the preferred is cumulative and participating, but up to a limit of 12 percent. Let's take a look at each one of those interesting scenarios and start with the simplified form, which is the noncumulative, nonparticipating. Remember that because we're going to stick to that number quite a lot. The eight percent times the 600,000 that is the 48,000 that is designed to be paid out for each year to the preferred stockholder. The 900 common stockholders, we do not pay them as a percentage unless it's participating that's where we're going to use the 900 when we get to the letters c and letter d requirements. We will use the 900,000. But here you go. The preferred, the 48,000 is simply this 8 percent times the 600,000. Common did not take anything. Remainder goes because it's noncumulative, nonparticipating. All the remaining out of the 306 will go to the common stockholders, and that is the allocation, so the preferred comes with 48,000 and the common will receive 258,000 and total of 306 for both of them. Second case, now it's cumulative. If it's cumulative, then before I pay current year's dividends, I have to pay the dividends in arrears for the last two years, and that's the 48,000 each year times two that's the 96,000. Current years is 48,000, did not pay yet anything to the common stockholders. But after that, it all because it's not participating, it all goes to the common stockholders, so still the common stockholders received more than the preferred stock even with three years of dividends. That is why the feature of the participation come into place, and that is in letter c requirement. Now it's cumulative and fully participating. What does that mean? Here you go. The 96 I explained it exactly, where did that dividends in arrears. Now the current years I paid 48,000 for the preferred allocated 48,000. Before I go with the participation feature, I need to allocate an equivalent percentage to the common stockholders so that when you multiply the eight percent by the capital that is contributed by the common stockholders, which is the 900,000, that gives you the 72,000. Now it is fully participating. Now I wanted to up till now, I allocated the 96,000 and 120,000 out of the 306, 000, then the remaining is 90,000. I'm actually calculating a percentage of participation to be allocation and that's this six percent, 90,000 divided by 1,500,000. What is the 1,500,000? That's the 900,000 common stock holders, and 600,000 preferred stockholders, in total is 1,500,000. I need to allocate 90,000 equally. Equal percentage and that's why the six percent. When you take the six percent times the 600,000, that will give you the 36. When you take the six percent times the 900,000 by the common stockholders will give you the 54. Now you can see the benefit of the participation feature because in the previous two requirements, actually the common stockholders ended getting in dividends more than the preferred stockholders. The last scenario, cumulative, but the participation is up to 12 percent only and that's why I did not calculate here a percentage like I did in the six percent because now the participation is up to 12 percent. I already paid eight percent and that's dividends and arrears because cumulative. Current year dividends 48,000 which is the eight percent times the 600,000 equivalent amount, eight percent times the 900,000 for the common stockholders. The participation now is up to additional four percent. I took the four percent because in total 12 percent, the eight percent was given, so additional four percent. I took the four percent times 600,000, that's 24,000. I took the four percent times the 900,000, that's the 36,000. Whatever is remaining all goes to the common because the participation now was not fully participating, was up till 12 percent in total. That's where I got the four percent additional, which is the 12 percent minus the eight percent that was allocated to the preferred and to the common. Hopefully, this example will give you good idea about how to allocate a certain amount of dividends among preferred stockholders and common stockholders in different situations and under different terms for the preferred stockholders. Thank you.
