Question

If a firm has retained earnings of $4.0 million, a common shares account of $6.0 million, and additional paid-in capital of $12.0 million, how would these accounts change in response to a 10 percent stock dividend? Assume market value of equity is equal to book value of equity.

(Enter your answers in dollars not in millions. Input all amounts as positive values. Indicate the direction of the effect by selecting "increase" , "decrease" and "no change" from the dropdown menu.)

Retained earnings	Increase or decrease or no change	$
Common Stock	Increase or decrease or no change	$
Additonal Paid-in-capital	Increase or decrease or no change	$

Answer 1

Solution :

A dividend payment reduces the Retained earning as the company is paying the dividends to shareholder through retained earning and Common stock and additional paid-in capital will increase. The overall shareholder's equity that consists of these three items remains unchanged.

The book value of equity = Common stock + additional paid in + Retained earning = 6 +12 + 4 = 20 million

GIven that Book value = Market value

And dividend payment = 10% of market value of equity = 10% * 20 million = 2 million

So retained earning account will decrease by $2,000,000

Here par value is not given so

Assuming that fair market value is reflected in the relative size of those two accounts,

So Common share account has weight of 6 /( 6+12) = 1/3 and paid-up capital account has 12/ (6+12) = 2/3

Amount added to common share account = 2,000,000 *1/3= 666,666.67

Amount added to paid in capital = 2,000,000*2/3 = 1,333,333.33

Retained Earning : decrease by : 2,000,000

Common stock : Increase by : 666,666.67

Additional paid in : Increase by : 1,333,333.33