Question

Bane Co. announced its regular quarterly cash dividend of $0.20 per share. Currently there are 1,000,000 shares outstanding

Declaration date: October 24, 2018

Ex-dividend date: November 20, 2018

Record date: November 22, 2018

Payment date: December 15, 2018

A) Suppose that the marginal tax rate on dividend is 15% and the marginal tax rate on capital gain is 10%, how much is the stock price likely to fall?

B) Suppose that the company decides to issue a 10% stock dividend instead of a cash dividend. How much is the stock price likely to fall? Let P’ be the new price after the stock dividend. We know that the number of shares outstanding will increase by a factor of 1.1 after the dividend, but the total value of equity does not change.

Answer 1

A) As a result of dividend payment, the stock prices should fall post ex-dividend date. The rate of decline in share price is calculated as follows:

=(Dividend Amount*(1-mariginal tax rate on dividend) / (1-capital gain tax) = (0.20*(1-0.15))/(1-0.10) = $0.1889

B) Since, there is no cash outflow in case of stock dividends, the value of equity does not decline.

The number of shares outstanding however, will increase by 10% = 1000,000*(1+0.10) = 1,100,000 shares

However, the gross value will remain constant, Let's assume it to be $X per share, prior to share dividend

Total gross equity value prior to share dividend = 1,000,000X, which will now be the gross equity value of 1,100,000 shares

Value per share = 1,000,000X/ 1,100,000 = 0.9091X

Therefore decrease in value per share = (X - 0.9091X)/X = 9.091%