When a company desires to increase the market value per share of common stock, the company will implement
Answer (B) is correct. A reverse stock split decreases the number of shares outstanding, thereby increasing the market price per share. A reverse stock split may be desirable when a stock is selling at such a low price that management is concerned that investors will avoid the stock because it has an undesirable image.
Arch, Inc., has 200,000 shares of common stock outstanding. Net income for the recently ended fiscal year was $500,000, and the stock has a price- earnings ratio of eight. The board of directors has just declared a three-for-two stock split. For an investor who owns 100 shares of stock before the split, the approximate value (rounded to the nearest dollar) of the investment in Arch stock immediately after the split is
Answer (C) is correct. EPS equals $2.50 ($500,000 NI ÷ 200,000 pre-split shares). Thus, 100 shares had a value of $2,000 (100 shares × $2.50 EPS × 8 P/E ratio) before the split. This value is unchanged by the stock split. Although the stockholder has more shares, the total value of the investment is the same.
On August 15, National Corporation announced a 1-for-10 reverse split, the event to occur on September 6, subject to shareholder approval. The stock’s closing price on August 4 was $1.375. If nothing changes, at what price would you expect the stock to sell after the stock split is made effective on September 6?
Answer (A) is correct. A reverse stock split, like a regular stock split, does not change the corporation’s market capitalization. Thus, if there are 1/10 as many shares outstanding as previously, they should be worth 10 times as much. Thus, the price after the reverse split would be $13.75 (10 × $1.375).
XYZ Corp. has 1,000 shares outstanding and retained earnings of $25,000. Theoretically, what would you expect to happen to the price of XYZ stock, currently selling for $50 per share, if a 20% stock dividend is declared?
Answer (C) is correct. The total market capitalization of 1,000 shares is $50,000. That should remain about the same following the issuance of the 200 shares of stock dividend. Thus, dividing $50,000 by 1,200 shares equals $41.67 per share.
If a company uses the residual dividend policy, it will pay
Answer (D) is correct. Under the residual theory of dividends, the amount (residual) of earnings paid as dividends depends on the available investment opportunities and the debt-equity ratio at which cost of capital is minimized. The rational investor should prefer reinvestment of retained earnings when the return exceeds what the investor could earn on investments of equal risk. However, the firm may prefer to pay dividends when investment opportunities are poor and the use of internal equity financing would move the firm away from its ideal capital structure.
Stock dividends and stock splits differ in that
Answer (C) is correct. A stock split does not involve any accounting entries. Instead, a larger number of new shares are issued to replace and retire all outstanding shares.
If the capital gains were taxed at a lower rate than regular dividend income, then the the dividend payout percentage of a company, the , everything else equal.
Answer (C) is correct. Lower dividend payout ratios will be favored by investors if dividends are taxed at a higher rate than capital gains. The cost of equity for the company will be lower under the lower dividend payout policy because more retained earnings will be available for reinvestment.
On December , Charles Company’s board of directors declared a cash dividend of $1.00 per share on the 50,000 shares of common stock outstanding. The company also has 5,000 shares of treasury stock. Shareholders of record on December 15 are eligible for the dividend, which is to be paid on January 1. On December 1, the company should
Answer (B) is correct. Dividends are recorded on their declaration date by a debit to retained earnings and a credit to dividends payable. The dividend is the amount payable to all shares outstanding. Treasury stock is not eligible for dividends because it is not outstanding. Thus, the December 1 entry is to debit retained earnings and credit dividends payable for $50,000 (50,000 × $1).
A company following a residual dividend payout policy will pay higher dividends when, everything else equal, it has
Answer (A) is correct. Under the residual theory of dividends, the firm prefers to pay dividends when investment opportunities are poor and internal financing would move the firm away from its ideal capital structure. Thus, a company with less-attractive investment opportunities will have a lower optimal capital budget. Under a residual dividend policy, a lower optimal capital budget will result in a higher dividend payout ratio, other factors being constant.
The date when the right to a dividend expires is called the
Answer (B) is correct. The ex-dividend date is 4 days before the date of record. Unlike the other relevant dates, it is not established by the corporate board of directors but by the stock exchanges. The period between the ex-dividend date and the date of record gives the stock exchange members time to process any transactions in time for the new shareholders to receive the dividend to which they are entitled. An investor who buys a share of stock before the ex-dividend date will receive the dividend that has been previously declared. An investor who buys after the ex-dividend date (but before the date of record or payment date) will not receive the declared dividend.