Question

Which of the following reduces the number of outstanding shares and increases the share price proportionately?

		a. A DRIP.
		b. A reverse stock split.
		c. A stock dividend.
		d. A stock spin-off.

Answer 1

Option b) A reverse Stock split is the Correct answer.

b. Reverse Stock Split: A reverse stock split is a type of corporate action which consolidates the number of existing shares of stock into fewer, proportionally more valuable, shares.

The process involves a company reducing the total number of its outstanding shares in the open market.

Ex: Consider a Company with 2: 1 Reverse Stock split

2: 1 Reverse Stock Split indicates that for every 2 shares investors get 1 Share

S.No	Particulars	Before Reverse Stock Split	After Reverse Stock Split
A	No.of Shares Outstanding	100000	50,000
B	Share Price	$10	20( $ 10,00000/50000)
C	Market Capitalization ( A*B)	$1,000,000	$1,000,000

In this case the Market Capitalization remains same where as no.of Shares are decreased with Proportionate increase in the No.of shares.

So reverse stock split reduces the Number of Outstanding shares and increase the share price Proportionately.

Hence Option b. Reverse stock split isthe Correct answer.

a. DRIP:

DRIP stands for Dividend Reinvestment plan.In this case, cash dividends are reinvested to purchase more stock in the company.So the No.of Shares will increase in this scenario to the shareholder.

So in this case shares are neither decreased nor the share price increases. So option a is not the Correct answer.

c.A Stock Dividend:

In this case when the dividend is issued in the form of shares, No.of shares will increase. So option c is not the Correct answer.

d.A stock spin off:

A spinoff is when a company takes a portion of its operations and breaks it off into a separate entity. In a spinoff, shares of the new company are distributed tax-free to shareholders of the parent company. So the shareholders get new shares in lieu of share in the existing Company.It neighther increases shares or sharevalue. So option d is not the Correct answer.