Question

Stock dividend and its effect [LO18-4]

Ace Products sells marked playing cards to blackjack dealers. It has not paid a dividend in many years, but is currently contemplating some kind of dividend.

The capital accounts for the firm are as follows:

Common stock (2,900,000 shares at $5 par)	$	14,500,000
Capital in excess of par*		6,000,000
Retained earnings		24,500,000
Net worth	$	45,000,000

*The increase in capital in excess of par as a result of a stock dividend is equal to the new shares created times (Market price − Par value).

The company’s stock is selling for $50 per share. The company had total earnings of $14,500,000 during the year. With 2,900,000 shares outstanding, earnings per share were $5. The firm has a P/E ratio of 10.

a. What adjustments would have to be made to the capital accounts for a 10 percent stock dividend? Show the new capital accounts. (Do not round intermediate calculations. Input your answers in dollars, not millions (e.g. $1,230,000).)

b. What adjustments would be made to EPS and the stock price? (Assume the P/E ratio remains constant.) (Do not round intermediate calculations and round your answers to 2 decimal places.)

c. How many shares would an investor end up with if he or she originally had 130 shares? (Do not round intermediate calculations and round your answer to the nearest whole share.)

d. What is the investor's total investment worth before and after the stock dividend if the P/E ratio remains constant? (Do not round intermediate calculations and round your answers to the nearest whole dollar.)

Answer 1

a. What adjustments would have to be made to the capital accounts for a 10 percent stock dividend? Show the new capital accounts. (Do not round intermediate calculations. Input your answers in dollars, not millions (e.g. $1,230,000).)

Since the stock dividend is 10%, it's a small stock dividend. Hence, amounts will be transferred from retained earnings to common stock and capital in excess of par account. Please see the table below for adjustments and new balances of the capital accounts.

Nos. of stocks outstanding prior to stock dividend = N₀ = 2,900,000

Stock dividend = 10%

New stocks to be issued, n = N₀ x 10% = 2,900,000 x 10% = 290,000

Face Value, FV = $ 5

Current market price, P = $ 50

Capital Account	Prior balance ($)	Adjustment ($)	New balances ($)
Common stock	14,500,000	+ n x FV = + 290,000 x 5 = +  1,450,000	15,950,000
Capital in excess of par*	6,000,000	+ n x (P - FV) = + 290,000 x (50 - 5) = +  13,050,000	19,050,000
Retained earnings	24,500,000	- n x P = - 290,000 x 50 = -14,500,000	10,000,000
Net worth	45,000,000	-	45,000,000

b. What adjustments would be made to EPS and the stock price? (Assume the P/E ratio remains constant.) (Do not round intermediate calculations and round your answers to 2 decimal places.)

New EPS = Net income / (N₀ + n) = 14,500,000 / (2,900,000 + 290,000) = $ 4.55

c. How many shares would an investor end up with if he or she originally had 130 shares? (Do not round intermediate calculations and round your answer to the nearest whole share.)

The new number of shares with the investor = 130 x (1 + 10%) = 143

d. What is the investor's total investment worth before and after the stock dividend if the P/E ratio remains constant? (Do not round intermediate calculations and round your answers to the nearest whole dollar.)

Investor's total investment prior to stock dividend = 130 x 50 = 6,500

New price = P / E ratio x new EPS = 10 x 4.55 = $ 45.5

Investor's total investment after the stock dividend = 143 x 45.5 = 6,500

Thus, the investor's total investment prior to and after the stock dividend, remains same at the level of $ 6,500