Treasury Stock and Total Equity The liability and stockholders’ equity sections of Lovata Corporation’s balance sheet appear as follows:

Lovata typically pays out 60 percent of its net income in dividends, a policy that it has followed for several decades and that stockholders have come to rely on. The company expects to earn $710,000 this year. Lovata has always made payments on its debt in a timely manner, but the company’s debt covenants specify that the debt is in technical default if the company’s ratio of total debt to equity excecdsplntonle During the past year, Lovata issued stock options to its employees as additional compensation. Because the exercise price of the options was equal to the market price of the stock on the date of grant, no value was assigned to the options.
The company expects that most of the options will be exercised within the next 2 years and wants to have shares available when that happens. The company also wants shares of its stock available for a future business combination it is considering. Accordingly, the company is considering buying back 20,000 of its shares in the open market. The stock currently is selling for $50 per share.
As the company’s newest financial analyst, you have been asked to evaluate the plan to repurchase company shares. Write a memo to the chief financial officer evaluating the desirability of issuing new shares versus purchasing treasury stock and make a recommendation as to how the company should proceed. Illustrate in your memo how the stockholders’ equity section of Lovata’s balance sheet would appear under the two different alternatives.

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Current liabilities Long-term debt $ 82,000 4,500,000 Total liabilities $4,582,000 Common stock ($10 par) $1,000,000 Additional paid-in capital 3,000,000 Retained earnings 1,200,000 Total equity 5,200,000 Total liabilities and equity $9,782,000