Lowe Tech Inc. has the following stockholders\' equity on June 30, 2016: Common
ID: 2474545 • Letter: L
Question
Lowe Tech Inc. has the following stockholders' equity on June 30, 2016:
Common Stock, $15 par (200,000 shares issued)
$3,000,000
Paid-in Capital in Excess of Par
2,000,000
Retained Earnings
4,000,000
Total Stockholders' Equity
$9,000,000
For the past three years, Lowe Tech Inc. has paid dividends of $1.60 per share. On July 1, 2016, the board declared a 20 percent stock dividend instead of the $1.60 cash dividend. Before the end of the year and after the stock dividend distribution, however, the board declared a cash dividend of $1.33 per share.
In June 2016, before the stock dividend was declared, Rosa Dodd purchased 12,000 shares of Lowe Tech Inc. stock for $60 per share. Now she is concerned because she purchased the stock expecting a $1.60 per-share dividend, only to learn that the dividend has been reduced to $1.33 per share.
Answer the following questions concerning this investment:
1. What could have caused Lowe Tech's board of directors to declare a stock dividend rather than a cash dividend in July?
2. How did the book value of Rosa's stock prior to the stock dividend compare with its book value after the stock dividend?
3. Why does the market value of the stock ($60) when Rosa purchased her shares differ from its book value at that time?
4. How does the total amount of cash dividends on Rosa's stock differ between the $1.60 per share on Rosa's original holdings and the $1.33 per share on her holdings after the stock dividend?
5. Assume the market price of the stock fell to $50 after the stock dividend was distributed. Does this drop represent a loss to Rosa?
6. What do you think would have happened to the market price of the stock if the board had not reduced the amount of the cash dividend per share of stock?
Common Stock, $15 par (200,000 shares issued)
$3,000,000
Paid-in Capital in Excess of Par
2,000,000
Retained Earnings
4,000,000
Total Stockholders' Equity
$9,000,000
Explanation / Answer
1.
The company might have declared stock dividend instead of cash dividend, that to reduce the market price of the shares. When the company thinks that the market price of the shares are too high then to reduce the market price the company issues stock dividend which lower down the market price of the shares.
The higher market prices have negative impact on demand of the shares therefore this is a company’s method to reduce the market price of the shares.
When the company does not have other assets to distribute it issues stock dividend. This is a method of transferring the amount of retained earnings to the contributed capital account.
2.
The book value of Rosa stock does not have any effect of the stock dividend issued because the holding percentage of the shareholders does not changes with the stock dividend issuance. The book value of stock will remain same before and after the issuance of stock dividend.
3.
Rosa has invested in stock of the company 1st June 2016 when the company is about to declare the dividends (1st July 2016) which has influenced the market price of the stock. The book value of the stock does not any impact of the declaration of the dividend.
4.
Cash dividend @ $1.33 received after stock dividend would be as under:
Investment in company=12,000 shares
Stock dividend of 20%=(12,000*20%)=2,400 shares
Total shareholding of Rosa=12,000+2,400
=14,400 shares
Cash dividend @ $1.33=(14,400*$1.33)=$19,152
Cash dividend @ $1.60 on original holding=(12,000*$1.60)=$19,000
Rosa has received $152 more of cash dividend from expected.
5.
If the market price fell to $50 then also Rosa will not be in loss because the number of shares holding has increased in the company. Earlier before stock dividend the value of shares she holds =12000 shares @ $60 per share. Now after stock dividend of 20% she is holding 14,400 shares @ $50 per share.
She is in no loss no gain position.
Value before stock dividend=(12,000 @ $60 per share)=$720,000
Value after stock dividend=(14,400@ $50 per share)=$720,000
6.
The market price would be increased if the board has not declared the lower cash dividend per share.
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