Question

Q#1.   Apple, Inc. (AAPL) announced in 2013 a 7-for-1 stock split. Similarly, many other publicly traded companies have announced stocks splits. Most stock holders as well as some analysts and traders believe that a stock split would definitely benefit current shareholders and raise the firm’s overall market value. You read in chapter 14 that, in theory, a 7:1 split would increase the number of outstanding shares seven fold and cut down the post-split stock price to 1/7 of pre-split price, thus leaving Apple's shareholders' wealth unchanged. This theory asserts that stock prices should increase only when a firm generates more earnings (cash flows) which will raise earnings per share. But stock splits do not generate any additional earnings (cash flows) for the firm. So you are puzzled why some shareholders, traders, and analysts adamantly believe that stock splits benefit shareholders. Please explain whether or not stock splits in general would benefit a firm's current shareholders with at least a 5-year investment (holding) horizon. You would want to use your understanding of chapter 14 stock split material, especially the signaling aspects of stock splits, optimal stock price range theory, and past empirical evidence in your explanation. Limit your answers to no more than ten (10) sentences.

Answer 1

Solution :-

1. Due to the stock split there is no change in the financial position or the profitability of the company only the change comes is that the number of outstanding shares are increased.

2. The Stpit of the stock is only increased the cost as the cost of issuing new share certificates and the increased costs of the admnistrative expenses.

There are various theories related to it :-

3. Signalling theory :- As per this theory explanation managers proceed with stock splits only to emenate positive vibes across the investing public that is about the company's financial health or position.

The existing shareholders should ask that if there is everything good in the company then what is the need of this stock split.

4. Optimal trading range theory :- Company can split the stock when the price of the stock becomes too high and it becomes out of reach of potential investors that makes low trade volume. By the Stock split the share of the company becomes tradeable. this theory can take a simple assumption that if the price of the stock is low then there is a high trade volume in it .

But in this theory the existing shareholders will stand to lose on EPS , on account of new entrant-shareholders amongst whom the total earnings will be divided.

6. Also there is a chance of dillution of control due to the spliting in the stock price and also a possibility of diffused ownership.

Thus stock-splits may not be to the advantageous for the existing shareholders--except for those shareholders or owners want to sell their shares--as marketability & liquidity was increased after the spliting of the share price.