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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
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...
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