Smoky Joe’s, Inc., a rapidly growing chain of BBQ restaurants, has had considerable increases in the...

Smoky Joe’s, Inc., a rapidly growing chain of BBQ restaurants, has had considerable increases in the value of their common stock over the years. Normally, the Board of Directors declares a modest cash dividend. But this year, they decided to issue a 50% stock dividend. Your friend, a new investor that saw potential in the company early on, came to you excited about the news, saying that he is getting free stock and that this is much better than the cash dividends from last year. Using what you have learned in accounting thus far, respond to your friend’s statement including the following points:

What does a 50% stock dividend really mean?

Is your friend really getting “free stock”?

Which would you prefer, a cash dividend or a stock dividend?

Solutions

Expert Solution

Answer to Question 1

50% stock dividend means that a person will get additional shares as percentage of his existing holdings. For example if a person holds 100 shares in the Company and Board of Directors of company announce 50% stock dividend it means he will get additional 50 shares of the company.

Answer to Question 2

Yes, he is getting free stock because his cost of holding per stock will come down though his value of holding remain unchanged. For example, suppose a person is holding 100 shares at value of $100. His cost per share is $1. After stock dividend of 50 shares his cost per share will decrease to 0.67 cents to adjust the dividend payout.

Answer to Question 3

It depends on risk appetite of person. If person is risk seeker he will prefer stock dividend or if he is risk averse he will prefer to go with cash dividend.

I will prefer stock dividend, because there is no tax on receiving stock dividend as compare to cash dividend where I will have to pay taxes as soon as I receive cash dividend. In stock dividend I have option to hold the stock or convert it into cash whereas in cash dividend there is no option given.

ekkarill92 answered 1 year ago

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