Question

An all-equity firm has 10M shares outstanding, trading at $80/share. Managers are thinking about executing a 2-for-1 stock split.

(A) What is currently the value of the firm?

(B) Absent of externalities, what do you expect the value of the firm and the stock price to be after the stock split?

(C) Suppose managers believe that the “ideal” stock price is $20/share. Absent of externalities, what stock split would managers need to execute to achieve this price?

(D) Suppose managers execute the stock split in Part (C). Now, taking externalities of such transactions into consideration, what do you expect firm value to be after the stock split and why?

Please show work in detail

Answer 1

a.

current value = price*shares = 10*80 = 800mln

b.

shares after split = shares before split*split ratio = 10*2/1 = 20mln

price after split = price before split*(1/split ratio) = 80*(1/(2/1)) = 40

Value = shares after split*price after split = 20*40 = 800 mln

c.

split ratio = current price/ideal stock price = 80/20 = 4 to 1

d.

shares after split = shares before split*split ratio = 10*4/1 = 40mln

price after split = price before split*(1/split ratio) = 80*(1/(4/1)) = 20

Value = shares after split*price after split = 40*20 = 800 mln