However if the firms earnings and cash dividends

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: he firm remains unchanged. The shareholder’s proportion of ownership in the firm also remains the same, and as long as the firm’s earnings remain unchanged, so does his or her share of total earnings. (However, if the firm’s earnings and cash dividends increase when the stock dividend is issued, an increase in share value is likely to result.) EXAMPLE Ms. X owned 10,000 shares of Garrison Corporation’s stock. The company’s most recent earnings were $220,000, and earnings are not expected to change in the near future. Before the stock dividend, Ms. X owned 10% (10,000 shares 100,000 shares) of the firm’s stock, which was selling for $15 per share. Earnings per share were $2.20 ($220,000 100,000 shares). Because Ms. X owned 574 PART 4 Long-Term Financial Decisions 10,000 shares, her earnings were $22,000 ($2.20 per share 10,000 shares). After receiving the 10% stock dividend, Ms. X has 11,000 shares, which again is 10% of the ownership (11,000 shares 110,000 shares). The market price of the stock can be expected to drop to $13.64 per share [$15 (1.00 1.10)], which means that the market value of Ms. X’s holdings is $150,000 (11,000 shares $13.64 per share). This is the same as the initial value of her holdings (10,000 shares $15 per share). The future earnings per share drops to $2 ($220,000 110,000 shares) because the same $220,000 in earnings must now be divided among 110,000 shares. Because Ms. X still owns 10% of the stock, her share of total earnings is still $22,000 ($2 per share 11,000 shares). In summary, if the firm’s earnings remain constant and total cash dividends do not increase, a stock dividend results in a lower per-share market value for the firm’s stock. The Company’s Viewpoint Stock dividends are more costly to issue than cash dividends, but certain advantages may outweigh these costs. Firms find the stock dividend a way to give owners something without having to use cash. Generally, when a firm needs to preserve cash to finance rapid growth, a stock dividend is used. When the stockholders recognize that the firm is reinvesting the cash flow so as to maximize future earnings, the market value of the firm should at least remain unchanged. However, if the stock dividend is paid so that cash can be retained to satisfy past-due bills, a decline in market value may result. Stock Splits stock split A method commonly used to lower the market price of a firm’s stock by increasing the number of shares belonging to each shareholder. EXAMPLE Although not a type of dividend, stock splits have an effect on a firm’s share price similar to that of stock dividends. A stock split is a method commonly used to lower the market price of a firm’s stock by increasing the number of shares belonging to each shareholder. In a 2-for-1 split, for example, two new shares are exchanged for each old share, with each new share worth half the value of each old share. A stock split has no effect on the firm’s capital structure. Quite often, a firm believe...
View Full Document

This document was uploaded on 01/19/2014.

Ask a homework question - tutors are online