Question

All other things equal, a stock dividend will have which of the following effects on shareholder's wealth?

Select one:

a. Stock dividends and shareholder wealth are not related.

b. Shareholder's wealth should be increased

c. Shareholder's wealth should be reduced.

d. Shareholder's wealth should remain constant.

Answer 1

Answer - Option D i.e Shareholder's wealth should remain constant.

Explanation

Shareholder wealth is defined total value of returns to the owners (that is, shareholders). It can be therefore arrived at by adding value of stock holding. It thereby includes market price of share and divided received by the holder

If capital markets are perfect, the dividend payout will result in a decrease in stock price for the amount of dividend per share.

Numerical problem as example (may not be part of solution)

We know PO = (D1 + P1) / (I + K)

Where,

PO = Prevailing market price of a share
P1 = Market Price of Share at the end of period one
K = Cost of equity Share
D1 = Dividend to be received at the end of period one.
I = Interest rate

Therefore,

P1 = PO (I+K) – D1

So, if share price of company is $100 each and the Company is contemplating $10 Per Share Dividend at the end of the earned year. And rate of return is 8%

Then, price shall be as under

When dividend is not paid:

P1 = $100 (1 + 0.08) – 0

= 100 x 1.08

=$108

When dividend is paid:

P1 = 100 (1 + 0.08) – 10

= 100 x 1.08 – 10

=$ 98

Shareholder's wealth in case of no divided = Stock price = 108

Shareholder's wealth in case of divided = stock price + divided

=98+10

=108