Stock Dividends and Stock Splits

Stock Dividends
Stock Dividend -- A payment of additional shares of stock to shareholders. Often used in place of or in addition to a cash dividend.

Small-percentage stock dividends / Small Share Dividends

Typically less than 20%-25% of previously outstanding common stock. Assume a company with 400,000 shares of $5 par common stock outstanding pays a 5% stock dividend. The pre-dividend market value is $40. How does this impact the shareholders equity accounts?

B/S Changes for the Small-Percentage Stock Dividends

$800,000 ($40 x 20,000 new shares) transferred (on paper) out of retained earnings. $100,000 transferred into common stock account. $700,000 ($800,000 - $100,000) transferred into additional paid-in-capital. Total shareholders equity remains unchanged at $10 million.

Small-Percentage Stock Dividends

Before 5% Stock Dividend Common stock ($5 par; 400,000 shares) Additional paid-in capital Retained earnings Total shareholders equity After 5% Stock Dividend $ 2,000,000 1,000,000 7,000,000 $10,000,000

Common stock ($5 par; 420,000 shares) Additional paid-in capital Retained earnings Total shareholders equity

$ 2,100,000 1,700,000 6,200,000 $10,000,000

Pre-stock Dividend Price

The market price of each share of stock should decline in proportion to the number of new shares issued. This relationship can be expressed as follows:
+ $ +.

Pre-stock dividend price =

=

= $38.10

Pre-stock Dividend Price

Prior to dividend, the stockholders wealth: 100 shares x $40 per share = $4,000
After: 105 shares x $38.10 per share = $4,000

Stock Dividends, EPS, and Total Earnings

After a small-percentage stock dividend, what happens to EPS and total earnings of individual investors?
Assume that investor SP owns 10,000 shares and the firm earned $2.50 per share. Total earnings = $2.50 x 10,000 = $25,000. After the 5% dividend, investor SP owns 10,500 shares and the same proportionate earnings of $25,000. EPS is then reduced to $2.38 per share because of the stock dividend ($25,000 / 10,500 shares = $2.38 EPS).

Large-Percentage Stock Dividend

Typically 20%-25% or greater of previously outstanding common stock. The material effect on the market price per share causes the transaction to be accounted for differently. Reclassification is limited to the par value of additional shares rather than pre-stock-dividend value of additional shares. Assume a company with 400,000 shares of $5 par common stock outstanding pays a 100% stock dividend. The pre-stock-dividend market value per share is $40.

B/S Changes for the Large-Percentage Stock Dividends

$2 million ($5 x 400,000 new shares) transferred (on paper) out of retained earnings. $2 million transferred into common stock account.

Large-Percentage Stock Dividends

Before 100% Stock Dividend Common stock ($5 par; 400,000 shares) Additional paid-in capital Retained earnings Total shareholders equity After 100% Stock Dividend $ 2,000,000 1,000,000 7,000,000 $10,000,000

Common stock ($5 par; 800,000 shares) Additional paid-in capital Retained earnings Total shareholders equity

$ 4,000,000 1,000,000 5,000,000 $10,000,000

Reasons why firms declare stock dividends

Stock Splits
Stock Split -- An increase in the number of shares outstanding by reducing the par value of the stock.

Similar economic consequences as a 100% stock dividend. Primarily used to move the stock into a more popular trading range and increase share demand. Assume a company with 400,000 shares of $5 par common stock splits 2-for-1. How does this impact the shareholders equity accounts?

Stock Splits
Before 2-for-1 Stock Split Common stock ($5 par; 400,000 shares) Additional paid-in capital Retained earnings Total shareholders equity After 2-for-1 Stock Split $ 2,000,000 1,000,000 7,000,000 $10,000,000

Common stock ($2.50 par; 800,000 shares) Additional paid-in capital Retained earnings Total shareholders equity

$ 2,000,000 1,000,000 7,000,000 $10,000,000

Problem
The board of directors of Complex Computers has decided to declare a 20 percent stock dividend. The companys common stockholders equity is as follows:
Pre-Stock Dividend Common Stockholders Equity Common stock ($1 par, 100,000 shares) Contributed capital in excess of par Retained earnings Total common stockholders equity

1/2

$ 100,000 900,000 5,000,000 $ 6,000,000

Problem
The common stock of Complex Computers is currently trading at $80 a share. The company is growing rapidly and has never paid a cash dividend. a. Show the companys common stockholders equity after the stock dividend. b. Calculate the post-stock dividend price of Complex Computers stock, assuming no other changes occur.

2/2

Answer

a.

Before 20% Stock Dividend Common stock ($1 par; 100,000 shares) Additional paid-in capital Retained earnings Total shareholders equity $ 100,000 900,000 5,000,000 $ 6,000,000

After 20% Stock Dividend Post-Stock Dividend Common Stockholders Equity Common stock ($1 par; 120,000 shares) $ 120,000 Additional paid-in capital 2,480,000 Retained earnings 3,400,000 Total shareholders equity $ 6,000,000

1/2

Answer

b.
Pre-stock dividend price =
+

$ +.

= $66.67
2/2

THE END