Question

When stock split is made by a company, immediately its share price:- Select one:

a. Increases sharply b. None of these c. Decreases almost proportionately d. Does not change at all

Answer 1

When stock split is made by a company, immediately its share price:-

c)  Decreases almost proportionately

Explanation :-

A stock split is a corporate action in which a company divides its existing shares into multiple shares. A stock split is a decision by the company's board to increase the number of outstanding shares. If it decides to split the stock, instead of one share of a particular face value, the share holder will have two shares of the same yet equally divided face value. The stock can be even be split in a 3-for-1 or 5-for-1 manner.

The companies choose to split their shares so they can lower the trading price of their stock to a range deemed comfortable by most investors and increase liquidity of the shares.

When a stock split is implemented, the price of shares adjusts automatically in the markets. A company's board of directors makes the decision to split the stock into any number of ways. For example, a stock split may be 2-for-1, 3-for-1, 5-for-1, 10-for-1, 100-for-1, etc. A 3-for-1 stock split means that for every one share held by an investor, there will now be three. In other words, the number of outstanding shares in the market will triple. On the other hand, the price per share after the 3-for-1 stock split will be reduced by dividing the price by 3. This way, the company's overall value, measured by the market capitalization, would remain the same.

Although the number of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts, because the split does not add any real value.

The most common split ratios are 2-for-1 or 3-for-1, which means that the stockholder will have two or three shares, respectively, for every share held earlier.

Market capitalization is calculated by multiplying the total number of shares outstanding by the price per share. For example, assume that XYZ Corp. has 20 million shares outstanding and the shares are trading at $100. Its market cap will be 20 million shares x $100 = $2 billion. Let's say the company’s board of directors decides to split the stock 2-for-1. Right after the split takes effect, the number of shares outstanding would double to 40 million, while the share price would be halved to $50, leaving the market cap unchanged at 40 million shares x $50 = $2 billion.

Reason for stock split
Sometimes the price of a company's shares rise so much that it may discourage investors from buying them. So, the company decides to reduce the cost per share with a stock split. This also helps it increase its overall liquidity as new investors may get interested in purchasing shares.

Benefits of stock split for investors
A stockholder will get two or three shares for one without any cost, making it easier to carry out trades. Also, stock splits can be a good way for retail investors to accumulate a higher number of shares of blue-chip companies which are usually expensive.