Question

Stock dividends and stock splits

Companies sometimes employ stock splits to bring down the price of its shares so that the stock is more attractive to potential investors.

Consider the case of Green Moose Industries:

Green Moose Industries currently has 25,000 shares of common stock outstanding. Its management believes that its current stock price of $110 per share is too high. The company is planning to conduct a 2-for-1 stock split.

If Green Moose Industries declares a 2-for-1 stock split, the price of the company’s stock after the split—assuming that the total value of the firm’s stock remains the same before and after the split—should be     per share.

Blue Elk Manufacturing is one of Green Moose’s leading competitors. Blue Elk’s market intelligence research team has learned of Green Moose’s stock split plans, and is considering paying a stock dividend to its own shareholders. As a result, executives at Blue Elk decide to offer stock dividends to its shareholders. Blue Elk Manufacturing currently has 2,750,000 shares of common stock outstanding.

If Blue Elk pays a 5% stock dividend, how many total shares of common stock will be outstanding after the stock dividend?

2,454,375 shares

2,743,125 shares

3,465,000 shares

2,887,500 shares

Answer 1

Green Moose Industries:

Number of Shares Outstanding = 25000, Price per Share = $ 110, Total Firm Value = V = 25000 x 110 = $ 2750000

Stock Split: 2 for 1 which implies issuing two stocks for every stock outstanding

Therefore, Number of Shares Outstanding post Stock Split = 2 x 25000 = 50000

Assuming, the total firm value remains constant after the split, the price per share = 2750000 / 50000 = $ 55

Blue Elk Manufacturing:

Number of Shares Outstanding = 2750000, Stock Dividend = 5 %

Number of Shares Issued as part of Stock Dividends = 2750000 x 0.05 = 137500

Total Number of Shares Outstanding post Stock Dividend = 2750000 + 137500 = 2887500

Hence, the correct option is (d)