Question: Worst Buy Company has had a lot of complaints from customers of late, and its stock price is now only $2 per share. It is going to employ a one-for-five reverse stock split to increase the stock value. Assume Dean Smith owns 140 shares.

a. How many shares will he own after the reverse stock split?

b. What is the anticipated price of the stock after the reverse stock split?

c. Because investors often have a negative reaction to a reverse stock split, assume the stock only goes up to 80 percent of the value computed in part b. What will the stock’s price be?

d. How has the total value of Dean Smith’s holdings changed from before the reverse stock split to after the reverse stock split (based on the stock value computed in part c)? To get the total value before and after the split, multiply the shares held times the stock price.

Step by step solution

01

Calculation of shares held after reverse stock split

The shares held after reverse stock split is 28 shares.

$$\begin{gathered} Numberofshares=\frac{Sharesheld}{Reversesplitratio} \\ =\frac{140}{5} \\ =28 \end{gathered}$$

02

Calculation of anticipated stock price after stock split

The anticipated stock price after stock split will be $10.

$$\begin{gathered} Stockprice=Originalstockprice\times Reversesplitratio \\ =\$2\times 5 \\ =\$10 \end{gathered}$$

03

Calculation of anticipated stock price after stock split based on 80% assumption

The anticipated stock price before stock split will be $8.

$$\begin{gathered} Stockprice=Anticipatedstockprice\times 80\%assumption \\ =\$10\times 80\% \\ =\$8 \end{gathered}$$

04

Calculation of value of holding before and after stock split

The value of holding before stock split is $280 and after stock split will be $224.

$$\begin{gathered} Valueofholding=Sharesheld\times stockprice \\ =140\times \$2 \\ =\$280 \\ Valueofholding=Sharesheld\times stockprice \\ =28\times \$8 \\ =\$224 \end{gathered}$$

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