Question

1. The management of Oodles of Noodles Inc. is contemplating a 30% stock dividend. The company currently has cash of $250,000, fixed assets of $5 million, and debt of $3 million. Its net income for the most recent fiscal year was $800,000. The company’s shares are currently selling for $25 per share, and it has 1 million shares outstanding. Assume that there are no costs associated with issuing a stock dividend.        

a.   What would be the effect of such a stock dividend on the following?

i.    Number of shares outstanding                                                          (1 mark)

ii.   Earnings                                                                                                  (1 mark)

iii. Market value of cash                                                                                       (1 mark)

iv. Market value of equity                                                                        (1 mark)

v.   Share price                                                                                          

vi. Earnings per share (EPS)                                                                

vii. Price-earnings ratio (P/E)                                                                          

viii.            Shareholders’ wealth                                                                                    

b.   If the company’s management would like to hold its EPS within the range of 0.7‑0.9, should the company go ahead with the stock dividend?                  (1 mark)

c.   If the company’s shareholders only care about their wealth and the P/E ratio, should the company go ahead with the stock dividend?                              (1 mark)

Answer 1

In a stock dividend, additional shares are issued to existing shareholder instead of distributing cash dividends

a]

i]

Number of shares outstanding will increase by 30%.

Shares outstanding after stock dividend = 1 million * (1 + 30%) = 1.3 million shares

ii]

Earnings before dividend will be unchanged, as the dividend is paid out of net income.

iii]

Market value of cash will be unchanged as no cash is distributed to shareholders

iv]

Market value of equity will be unchanged as the stock price will adjust to account for the stock dividend

v]

Share price will adjust to account for the stock dividend.

Stock price after dividend = market value of equity / Shares outstanding after stock dividend

Stock price after dividend = ($25 * 1 million) / 1.3 million = $19.23

vi]

EPS after dividend =   net income / Shares outstanding after stock dividend

EPS after dividend = $800,000 / 1.3 million = $0.615