Rupert Is Starting Up a New High-Tech Business and Needs

question 59

Essay

Rupert is starting up a new high-tech business and needs to be able to attract some of the best computer programmers available.He has set up a corporation to carry on the business.It has two classes of shares: common shares which vote, and are entitled to receive dividends and the remaining property of the corporation on dissolution, and Class A preferred shares, which do not vote but are entitled to an annual dividend of 10 percent of the issue price and, on dissolution, to receive the amount invested in return for the preferred shares.Dividends on the Class A preferred shares must be paid before any dividends are paid on the common shares.Also, no payment on dissolution can be made to the holders of the common shares until payment is made to the holders of Class A preferred shares.Rupert holds all of the 100 common shares the corporation has issued.He expects that the common shares of the business will be sold in a couple of years for an enormous profit because the business will grow very fast.No Class A preferred shares have been issued.In order to attract programmers, Rupert wants to be able to offer them shares in his corporation in addition to paying them a good salary.What kind of shares should these be? Are there any concerns Rupert should have regarding his strategy?

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Definitions:

Variable Costs

Costs that vary directly with the level of production or service delivery, such as materials, labor, and utilities.

Internal Rate Of Return

A financial metric used to evaluate the profitability of investments, representing the interest rate at which the net present value of costs and benefits of a project break even.

Salvage Value

The anticipated salvage value of an asset at the termination of its service life.

Annual Cash Flows

The total amount of money being transferred into and out of a business, especially affecting liquidity, within a year.