Chapter14PayoutPolicy53

P1415. Stocksplitversusstockdividendfirm
LG5,6;Challenge
a. Preferredstock $500,000
Commonstock(225,000sharesat$4par) 900,000
Paidincapitalinexcessofpar 2,850,000
Retainedearnings 760,000
Totalstockholdersequity $5,010,000
b. Marketpriceofstockswilldropimmediatelyafterasplitto$16.67or($252/3).
c. Beforestocksplit=760,000/150,000
=$5.07
Afterthestocksplit=760,000/225,000
=$3.3
d. Maximumcashdividendbeforesplit=200$5.07
=$1,014
Maximumcashdividendaftersplit=300$3.38
=$1,014
Basedonthemaximumcashdividend,thestockholdershouldbeindifferent.Forfuturedividends,the
stocksplitshouldyieldlargerdividendpayments.

e. Stocksplitisthemethodusedtolowerthemarketpriceofafirmsstockbyincreasingthenumberof
stockownedbythevariousstockholders.
Stockdividendsaredividendspaidtostockholders,notincashbutintheformofadditionstock.

P1417. Stockrepurchase
LG6;Intermediate
$400,000
a. Sharestoberepurchased = = 19,047shares
$21.00
$800,000 $800,000
b. EPS = = = $2.10pershare
(400,000 - 19,047) 380,953
If19,047sharesarerepurchased,thenumberofcommonsharesoutstandingwilldecreaseand
earningspersharewillincrease.
c. Marketprice:$2.1010=$21.00pershare.
d. Thestockrepurchaseresultsinanincreaseinearningspersharefrom$2.00to$2.10.
e. Theprerepurchasemarketpriceisdifferentfromthepostrepurchasemarketpricebytheamountof
thecashdividendpaid.Thepostrepurchasepriceishigherbecausefewersharesareoutstanding.
Cashdividendsaretaxabletothestockholderwhentheyaredistributedandaretaxedatamaximum
15%taxrate.Ifthefirmrepurchasesstock,taxesontheincreasedvalueresultingfromthepurchase
arealsodueatthetimeoftherepurchase.Theadditional$1gainwouldbetaxedateitherthelong
termcapitalgainsrateof15%,thesameasthedividend,unlessthestockwasheldforlessthanone
year;thenthegainwouldbeshorttermandtaxedatthehighermarginalordinaryincomerate.Which
alternativeispreferredbytheshareholderswoulddependontheinvestorsholdingperiodforthe
stockatthetimetherepurchaseismade.Taxeswouldnothavetobepaidontherepurchasegains
untilthesharesaresold.

PearsonEducationLimited,2015.