Case 1. (Learning Objective 2: Evaluating alternative ways of raising capital) Nate Santiago and Darla Perez 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. Santiago and Perez 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.

Santiago and Perez plan to receive 50,000 of the corporation’s ordinary shares 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, Santiago’s and Perez’s capital balances will each be $25,000.

The corporation’s plans for a constitution include an authorization to issue 10,000 preference shares and 500,000 shares of $1 par ordinary shares. Santiago and Perez are uncertain about the most desirable features for the preference shares. Prior to incorporating, Santiago and Perez 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 $100,000 to acquire 1,000 shares of 6%, $100 par non-voting, preference shares.
■ Plan 2. Group 2 will invest $60,000 to acquire 600 shares of $5, no-par preference shares and $50,000 to acquire 50,000 ordinary shares. Each preference share receives 50 votes on matters that come before the shareholders.
Requirements Assume that the business is now incorporated.
1. Journalize the issuance of ordinary shares to Santiago and Perez. Debit each person’s capital account for its balance.
2. Journalize the issuance of shares 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 shareholders’ 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)