Q#1 (8 points). You read in chapter 14 that a 2:1 split would double the number
ID: 2629946 • Letter: Q
Question
Q#1 (8 points). You read in chapter 14 that a 2:1 split would double the number of outstanding shares and half the earnings and dividends per share, thereby lowering the stock price. From a purely technical perspective, a 2:1 stock split simply provides additional pieces of paper and should not affect the overall wealth of shareholders (shares doubles, prices drop one-half). So you are puzzled why some shareholders, traders, and analysts adamantly believe that stock splits benefit shareholders. For example, Apple announced a 7:1 stock split (one oustanding share converted to seven new shares) in 2014 which was aimed in part in boosting the Apple's stcok price. Please explain concisely whether or not a 7:1 split would benefit Apple
Explanation / Answer
Stock splits were historically done because there was a commission cost advantage to trading in round lots (100 shares), and many investors could not (or chose not) to purchase 100 shares of a high price stock. This is no longer generally true, but some people still feel more comfortable buying lower priced stocks, say 100 shares of a $50 stock as opposed to 10 shares of a $500 one. There is a signalling aspect to stock splits; it is company managements way of telling shareholders that the future looks bright for their company, as companies rarely split stocks (unless it is a reverse split) if they are not confident about the future. Therefore a stock split will often cause an increase in the price of the stock not because of the split itself, but of the vote of confidence of managment in the company's future.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.