| 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% |
