Health Systems Inc. is considering a 10 percent stock dividend. The capital accounts are as follows:

Health Systems Inc. is considering a 10 percent stock dividend. The capital accounts are as follows:

   

Common stock (4,000,000 shares at $10 par)	$ 40,000,000
Capital in excess of par*	25,000,000
Retained earnings	45,000,000
Net worth	$110,000,000

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

   

The company’s stock is selling for $16 per share. The company had total earnings of $8,000,000 with 4,000,000 shares outstanding and earnings per share were $2.00. The firm has a P/E ratio of 8.

   

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).)

  

Common stock	$
Capital in excess of par
Retained earnings
Net worth	$

   

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.)

EPS	$
Stock price	$

c.	How many shares would an investor have if he or she originally had 70? (Do not round intermediate calculations and round your answer to the nearest whole share.)

   

Number of shares

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.)

   

	Total Investment
Before stock dividend	$
After stock dividend	$

e.	Assume Mr. Heart, the president of Health Systems, wishes to benefit stockholders by keeping the cash dividend at a previous level of $1.15 in spite of the fact that the stockholders how have 10 percent more shares. Because the cash dividend is not reduced, the stock price is assumed to remain at $16.
	What is an investor’s total investment worth after the stock dividend if he/she had 70 shares before the stock dividend?

       

Total investment

$

   

f.	Under the scenario described in part e, is the investor better off?
	Yes

   

g.	As a final question, what is the dividend yield on this stock under the scenario described in part e?(Input your answer as a percent rounded to 2 decimal places.)

   

Dividend yield

%

 
Explanation:

a.

After a 10 percent stock dividend:

Number of new shares	= Dividend percent × Number of shares outstanding
	= .10  × 4,000,000
	= 400,000 shares

Common stock	= Number of shares outstanding × Par value per share
	= (4,000,000 + 400,000) × $10
	= $44,000,000

Capital in excess of par	= Original account balance + [Number of new shares × (Stock price − Par value)]
	= $25,000,000 + [400,000 × ($16 − 10]
	= $27,400,000

Retained earnings	= Original account balance − (Number of new shares × Stock price)
	= $45,000,000 − (400,000 × $16)
	= $38,600,000

A stock dividend increases the common stock and capital in excess of par account values and decreases retained earnings. Total equity is unchanged.

  

b.

Post-split earnings per share	= Earnings / Number of shares
	= $8,000,000 / (4,000,000 + 400,000)
	= $1.82

Post-split price	= Price-earnings ratio × Earnings per share
	= 8 × $1.82
	= $14.55

c.

Post-split investor shares	= Original shares × (1 + Dividend percent)
	= 70 × (1 + .10)
	= 77 shares

d.

Pre-split investment value	= Pre-split stock price × Pre-split shares
	= $16 × 70
	= $1,120

Post-split investment value	= Post-split stock price × Post-split shares
	= $14.55 × 77
	= $1,120

e.

Investment value	= Stock price × Post-split shares
	= $16 × 77
	= $1,232

f.

Yes. As a result of keeping the cash dividend constant, the stockholder not only received more cash dividends, but the portolio value also increased as a result of having more shares.

g.

Dividend yield	= Dividend / Stock price
	= $1.15 / $16
	= .0719, or 7.19%