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10.     The management of Oodles N Noodles Inc. is contemplating a 20% stock dividend. The...

10.     The management of Oodles N Noodles Inc. is contemplating a 20% stock dividend. The company currently has cash of $300,000, fixed assets of $3.5 million, and debt of $1 million. Its net income for the most recent fiscal year was $500,000. The company’s shares are currently selling for $15 per share, and it has one million shares outstanding. Assume that there are no costs associated with issuing a stock dividend.                                                                        

a. Before issuing the stock dividend, the company’s management would like to know the effect of such a stock dividend on the following:

  1. The number of shares outstanding                                   (1 mark)
  2. Earnings                                                                   (1 mark)
  3. Market value of cash                                                    (1 mark)
  4. Market value of equity                                                  (1 mark)
  5. Share price                                                               
  6. Earnings per share (EPS)                                             
  7. Price-earnings ratio (P/E)                                             
  8. Shareholders’ wealth                                                   

b. The company’s management would like to hold its earnings per share within the range of 0.4–0.6. Given this constraint, should the company go ahead with the stock dividend?                               (1 mark)

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

Solutions

Expert Solution

For a 20% stock dividend on 1 Million outstanding shares
Number of shares to be issued as a dividend               200,000 (1million*20%)
i) Number of shares outstanding=1000000+200000           1,200,000
ii) Earnings $500000 A stock dividend has no effect on earnings.
iii) Market Value of Cash $300,000 A stock dividend has no effect on the market value of cash.
iv) Market Value of Equity $15,000,000 ($15*1million)                                                                                     A stock dividend has no effect on the market value of Equity. The increase in no. of outstanding shares is negated by the corresponding decrease in stock price. As such, there's no effect of a stock dividend.
v Share Price (15000000/1200000) $12.50
vi) Earnings per share (500000/1200000) $0.42
vii) Price Earning Ratio=12.50/0.42= 30 (No Change)
viii) Shareholders Wealth=12.50*1200000= $15,000,000 Shareholders' wealth remains the same as the decrease in price is compensated by an increase in No. of shares.
b Earning per share will be within the range 0.4-0.6
A company can go ahead with the stock dividend
c. If all that the shareholders care about is their
wealth and P/E ratio
A company should not go ahead with the stock dividend
The Stock dividend does not change these parameters

ekkarill92 answered 2 years ago
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