Question

Sumter Company manufactures televisions and they had a very successful
year.
They had 225,000 shares of common stock outstanding and they have decided
to do a 3-for -1 stock split.
Instructions:
a) What will be the number of shares outstanding after the split?
b) If the common stock had a par value $30 per share be
fore the
stock split, what would be the par value after the stock split?
c) If the common stock had a market price of $150 per share before
the stock split, what would be the approximate market price after
the stock split?

Answer 1

• General Concept regarding Stock Split summarised below for understanding:

--When 1 share is split into 2 or 3 (as the case may be), total number of shares outstanding INCREASES.

--The total value of stock remains the same, which means [No. of shares before split x Par value per share] = [No. of shares after stock split x New Par Value per share]

--This is because when no. of shares get increased, the par value per share decreases.

• Answer ‘a’

No. of shares outstanding after the split = 225,000 shares x (3/1) split ratio = 675,000 shares

• Answer ‘b’

Total value of common stock before split = 225000 shares x $ 30 par = $ 6,750,000

The par Value after the stock split = $ 6750000 / 675000 shares = $ 10 per share

Answer = $ 10 per share = new par value.

• Answer ‘c’

--The stock split is done by the company when the share market prices are so high that they become difficult to invest for small investors. Hence, the 1 share is broken into several shares, thereby lowering the market price.

--Market price is $ 150 per share before stock split.

--After Stock split, the market share price would decreases to approximately $ 50 per shares .[ $ 150 x 1/3]

--Answer = $ 50 per share.