On July 1, year 2, Metaro Corporation purchased for $108,000, 2,000 shares of Jean Corporation’s newly issued 6% cumulative $20 par value preferred stock. Each share also had one stock warrant attached, which entitled the holder to acquire, at $19, one share of Jean $10 par value common stock for each two warrants held. On July 2, year 2, the market price of the preferred stock (without warrants) was $50 per share and the market price of the stock warrants was $10 per warrant. On September 1, year 2, Metaro sold all the stock warrants for $19,800. What should be the gain on the sale of the stock warrants?

$1,800

Explanation:

The first step is to calculate the amount of purchase price allocated to the stock and to the warrants. This allocation is made on the basis of the ratios of the relative fair market values of the stock and warrants over the total fair market value of stock and warrants. The combined fair market value is $60 ($50 stock + $10 warrants). The allocation is Warrants:$10/$60 × $108,000 = $18,000 Stock: $50/$60 × $108,000 = $90,000 The final step is to compute the gain or loss on the sale of warrants by comparing the purchase price allocated to the warrants with the selling price of the warrants. The selling price was $19,800 and the allocation of purchase price was $18,000; therefore, the gain on the sale of warrants was $1,800

The gain on the sale of the stock warrants should be $1,800.

Explanation:

Allocate the purchase price of $108,000 to stock and warrants on the basis of their fair values.

Total Fair value = Fair value of stock + Fair value of warrant = $50 + $10 =$60

Allocation of Purchase price

Stock = $108,000 x $50 / $60 = $90,000

Warrant = $108,000 x $10 / $60 = $18,000

now the purchase value of warrant is $18,000

Gain on sales is the net of the Sale proceeds and the purchase price of the warrant.

Gain on sale of warrant = Sale proceeds - Purchase value = $19,800 - $18,000 = $1,800

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