Nate Smith and Darla Jones have written a computer program for a video game that may rival Playstation and Xbox. They need additional capital to market the product, and they plan to incorporate their business. Smith and Jones are considering alternative capital structures for the corporation. Their primary goal is to raise as much capital as possible without giving up control of the business. Smith and Jones plan to receive 50,000 shares of the corporation’s common stock in return for the net assets of their old business. After the old company s books are closed and the assets adjusted to current market value, Smiths and Jones capital balances will each be $25,000.

The corporation’s plans for a charter include an authorization to issue 10,000 shares of preferred stock and 500,000 shares of $1 par common stock. Smith and Jones are uncertain about the most desirable features for the preferred stock. Prior to incorporating, Smith and Jones are discussing their plans with two investment groups. The corporation can obtain capital from outside investors under either of the following plans:

Plan 1. Group 1 will invest $80,000 to acquire 800 shares of 6%, $100 par nonvoting, preferred stock.

Plan 2. Group 2 will invest $55,000 to acquire 500 shares of $5, no-par preferred stock and $35,000 to acquire 35,000 shares of common stock. Each preferred share receives 50 votes on matters that come before the stockholders.

Requirements

Assume that the corporation is chartered.

1. Journalize the issuance of common stock to Smith and Jones. Debit each persons capital account for its balance.

2. Journalize the issuance of stock to the outsiders under both plans.

3. Assume that net income for the first year is $120,000 and total dividends are $30,000.

Prepare the stockholders equity section of the corporation’s balance sheet under both plans.

4. Recommend one of the plans to Smith and Jones. Give your reasons. (Challenge)