Financial Decisions. 10 Stock Distributions. 1. Stock Dividends 2. Stock Splits. Instructor: A. Ashta

Transcription

1 Financial Decisions 1. Stock Dividends 2. Stock Splits 10 Stock Distributions Instructor: A. Ashta References: Ross, Westerfield & Jordan: Ch. 14 Emery, Finnerty & Stowe: Ch. 17 Shapiro & Balbirer: Ch. 15 1

2 Stock Dividends and Stock Splits Stock Dividends (expressed as percentage) Payment of additional shares to common stockholders. A 10% stock dividend means that shareholders get 1 additional share for every 10 they own. Stock Splits (expressed as ratio) A proportionate increase in the number of common shares. A 2:1 stock split means that stockholders will receive one additional share for every one they own. In both cases, share value is diluted but total equity remains the same NYSE: <25% = stock dividend >, = 25% = stock split 2

3 Stock Dividends A stock dividend proportionately increases the number of shares each shareholder owns. A 10% stock dividend: Increases total number of shares outstanding by 10%. Increases each shareholders holdings by 10%. If a shareholder own 50 shares before the dividend, she owns 55 shares after the stock dividend is paid. 3

4 Stock Dividends For a small stock dividend, the fair market value of these new shares is transferred from retained earnings to: Paid-in-capital and Capital contributed in excess of par value. Total common stockholder s equity remains unchanged. Par value of each share remains unchanged 4

5 Stock Splits The total number of shares outstanding increases. In a 3-for-2 stock split, 3 new shares are issued for every 2 pre-split shares outstanding. Thus, there is a 50% increase in the number of shares outstanding. A stock split alters the par value of the shares But there is no transfer of balances between the equity accounts(no transfer from reserves to share capital). 5

6 Financial Impact of Stock Distributions Apart from any informational effects, the total market value of the stock remains unchanged after a stock dividend or a stock split. Since the number of shares outstanding increases in either case, the per-share price will drop correspondingly. 6

7 Example of Stock Distributions Assume the share price is $45 before the stock distribution. After a 3-for-2 stock split, the share price will be After a 10% stock dividend, the share price would be 7

8 Accounting Treatment of Stock Dividends and Stock Splits A. Before: Common ($1 par; 1 $1M million shares) Add. paid in capital Retained earnings 9M 100M Total equity $110M Market price per share $50 8

9 Accounting Treatment of Stock Dividends and Stock Splits A. After 3:2 Stock split: Common ($ par; $ M million shares) Add. paid in capital M Retained earnings M Total equity $ M Market price per share$ x =$ 9

10 Accounting Treatment of Splits and Stock Dividends B. Small stock dividend (10%) new shares at $ each = $ M, so Common ($1 par; 1.1 $1.1M million shares) Add. paid in capital M Retained earnings M Total equity $110M Market price per share $ 10

11 Try Ross Q. 10 Stock Dividend 8% stock dividend declared Market price is $ 10 Equity: Common Stock ($ 1 par) 450,000 Capital Surplus 1,550,000 Retained Earnings 3,000,000 Total 5,000,000 11

12 Answer: Ross Q. 10 Dividend = shares = $ Total shares outstanding = shares 4 = $ Capital surplus for new shares = Retained earnings = Common stock ($1 par value) Capital surplus Retained earnings $ $ 12

13 Q. 11 of Ross Stock Split IF 5 for 1 stock split, what happens to equity accounts Equity:» Common Stock ($ 1 par) 450,000» Capital Surplus 1,550,000» Retained Earnings 3,000,000» Total 5,000,000 If cash dividend of 50 cents per new share represents a 10% increase on last year s dividend, what was last year s dividend? 13

14 Dividends this year = $0.50 x shares = $ Last year s dividend = $ / = $ Dividends per share last year = $ / shares = $ 14

15 Do Stock Distributions matter? Do they matter? Popular trading range argument Liquidity/ownership base Cosmetic effects Information effects How about reverse splits? The trading range argument again Can we buy respectability? Minimum price requirements Facilitating buyouts 15

16 Reasons for Stock Dividends and Stock Splits Keep share in popular trading range in order to appeal to small investors. ($10 to $30) This may broaden ownership of firm Allows investors to buy in normal lots rather than odd lots (more expensive) Stock dividends conserve cash while still maintaining a record of dividends. Signals management s confidence in the future. Have to pay more dividends However, increases in stock price will be transitory unless management delivers results. 16

17 Financial Impact of Stock Distributions After a stock dividend, the per-share cash dividend is usually unchanged. After a stock split, the cash dividend is either unchanged or reduced less than proportionately. In both cases, the cash dividend per original share increases. positive signal about firm value. 17

18 No Shareholder Value Added Stock distributions are paper transactions No shareholder value is added by paper changes In fact, shareholder value is destroyed Extra printing cost More brokerage fees on low value shares 18