Question: Ace Products sells marked playing cards to blackjack dealers. It has not paid a dividend in many years, but is currently contemplating some kind of dividend. The capital accounts for the firm are as follows:

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

The company’s stock is selling for \(20 per share. The company had total earnings of \)4,800,000 during the year. With 2,400,000 shares outstanding, earnings per share were \(2.00. The firm has a P/E ratio of 10.

a. What adjustments would have to be made to the capital accounts for a 10 percent stock dividend? Show the new capital accounts.

b. What adjustments would be made to EPS and the stock price? (Assume the P/E ratio remains constant.)

c. How many shares would an investor end up with if he or she originally had 70 shares?

d. What is the investor’s total investment worth before and after the stock dividend if the P/E ratio remains constant? (There may be a \)1 to $2 difference due to rounding.)

Step by step solution

01

New capital accounts

The common stock balance will be $13,200,000, balance of capital in excess of par will be $8,600,000, and the balance of retained earnings will be $18,200,000.

$$\begin{gathered} Capitalexcessinpar=Initialbalance+ \\ \left[Sharedissued\times \left(Marketprice-Parvalue\right)\right] \\ =\$5,000,000+\left[240,000\times \left(\$20-\$5\right)\right] \\ =\$5,000,000+\left[\$240,000-\$15\right] \\ =\$5,000,000+\$3,600,000 \\ =\$8,600,000 \end{gathered}$$

$$\begin{gathered} Retainedearning=Beginningbalance-Transfertocommonstock \\ -Transfertocapitalinexcessofpar \\ =\$23,000,000-\$1,200,000-\$3,600,000 \\ =\$18,200,000 \end{gathered}$$

02

Calculation of EPS and stock price after stock split

The EPS will be $ 1.82 and the stock price will be $18.2.

$$\begin{gathered} EPS=\frac{Earnings}{Sharesouts\tan ding} \\ =\frac{\$4,800,000}{2,640,000} \\ =\$1.82 \end{gathered}$$

$$\begin{gathered} Stockprice=EPS\times \raisebox{1ex}{$P$}\!\left/ \!\raisebox{-1ex}{$E$}\right.ratio \\ =\$1.82\times 10 \\ =\$18.2 \end{gathered}$$

03

Calculation of number of shares after stock split

The number of shares held after the stock split will be 77 shares$$\begin{gathered} Numberofshares=Sharesoriginallyheld\times Stockdividend \\ =70\left(70\times 10\%\right) \\ =70+7 \\ =77 \end{gathered}$$$$\begin{gathered} Numberofshares=Sharesoriginallyheld\times Stockdividend \\ =70+\left(70\times 10\%\right) \\ =70+7 \\ =77 \end{gathered}$$

04

Calculation of total investment worth before and after stock dividend

The investment’s worth before stock split will be $1,400 and after stock split will be $1,540.

$$\begin{gathered} Investment\text{'}sworth=Numberofshares\times Marketprice \\ =70\times \$20 \\ =\$1400 \end{gathered}$$

$$\begin{gathered} Investment\text{'}sworthafterstocksplit=Numberofshares\times Marketprice \\ =77\times \$22 \\ =\$1,540 \end{gathered}$$

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