Question

Health Systems Inc. is considering a 10 percent stock dividend. The capital accounts are as follows: Common stock (4,000,000 shares at $10 par) $ 40,000,000 Capital in excess of par* 25,000,000 Retained earnings 45,000,000 Net worth $ 110,000,000 *The increase in capital in excess of par as a result of a stock dividend is equal to the shares created times (Market price – Par value). The company’s stock is selling for $16 per share. The company had total earnings of $8,000,000 with 4,000,000 shares outstanding and earnings per share were $2.00. The firm has a P/E ratio of 8. a. What adjustments would have to be made to the capital accounts for a 10 percent stock dividend? Show the new capital accounts. (Do not round intermediate calculations. Input your answers in dollars, not millions (e.g. $1,230,000).) b. What adjustments would be made to EPS and the stock price? (Assume the P/E ratio remains constant.) (Do not round intermediate calculations and round your answers to 2 decimal places.) c. How many shares would an investor have if he or she originally had 70? (Do not round intermediate calculations and round your answer to the nearest whole share.) d. What is the investor’s total investment worth before and after the stock dividend if the P/E ratio remains constant? (Do not round intermediate calculations and round your answers to the nearest whole dollar.); e. Assume Mr. Heart, the president of Health Systems, wishes to benefit stockholders by keeping the cash dividend at a previous level of $1.15 in spite of the fact that the stockholders now have 10 percent more shares. Because the cash dividend is not reduced, the stock price is assumed to remain at $16. What is an investor’s total investment worth after the stock dividend if he/she had 70 shares before the stock dividend? f. Under the scenario described in part e, is the investor better off? Yes No g. As a final question, what is the dividend yield on this stock under the scenario described in part e? (Input your answer as a percent rounded to 2 decimal places.)

Answer 1

a) Stock dividend of 10% will be 4,000,000 shares x 10% = 400,000 shares

Total market value of 400,000 shares = 400,000 x 16 = $6,400,000

Following adjustments have to be made

Retained earnings have to be reduced by $ 6,400,000

Common stock will increase by $ 4,000,000 ($ 10 x 400,000)

Capital in excess of par will increase by $ 2,400,000 ( $ 6 x 400,000)

The new Capital accounts will be as follows ;-

Common Stock (4,400,000 shares at $10 par) $ 44,000,000

Capital in excess of par $ 27,400,000

Retained earnings $ 38,600,000

Net worth $ 110,000,000

b. Total Earnings =$ 8,000,000, Number .of outstanding shares is 4,400,000

Hence EPS = $,8000,000/ 4,400,000 = 1.82

Stock Price = Total Market value/Number of outstanding shares = $ 6,400,000/ 4,400,000 = $ 14.55

c. An investor who had 70 shares will have 70 + 10% x 70 = 77 shares

d.The investor' total investment worth before stock dividend = 70 x $16 = $ 1120

  The investor' total investment worth after stock dividend = 77 x $14.55 = $ 1120

e. If the cash dividend is not reduced and stock price is remains at $16, then investor's worth = 77 x $16=$1232

f. Yes. The investor is better off under scenario e. because his investment is worth more

g. Dividend yield = $1.15 /$16 = 7.19 %