Ace Products sells marked playing cards to blackjack dealers. It has not paid a

Question

Ace Products sells marked playing cards to blackjack dealers. It has not paid a dividend in many years, but is currently contemplating some kind of dividend. The capital accounts for the firm are as follows:

Common stock (2,000,000 shares at $5 par)                                                             $10,000,000

Capital in excess of par*                                                                                            6,000,000

Retained earnings                                                                                                       24,000,000

Net worth                                                                                                                      $40,000,000

*The increase in capital in excess of par as a result of a stock dividend is equal to the new shares created times (Market price - Par Value)

The company's stock is selling for $20 per share. The company had total earnings of $4,000,000 during the year. With 2,000,000 shares outstanding, earnings per share were $2.00. The firm has a P/E ratio of 10.

a. What adjustments would have to be made to the capital accounts for a 10 percent stock dividend? Show the new capital accounts.

b. What adjustments would be made to EPS and the stock price? (Assume the P/E ratio remains constant).

c. How many shares would an investor end up with if he or she originally had 100 shares?

d. What is the investor's total investment worth before and after the stock dividend if the P/E ratio remains constant? (There may be a $1 or $2 difference due to rounding)

e. Has Ace Products pulled a magic trick, or has it given the investor something of value. Explain.

Show all work!!

Explanation / Answer

a. When 10% stock dividend will be issued,

b.

e.

Ace Products has not pulled a magic trick. Value will remain same and investor will not receive anything.

The new capital accounts. Before Stock Dividend Addition After Stock Dividend Particulars Number of shares Amount $ Amount $ Number of shares Amount $ Common stock 2,000,000 1,00,00,000 10,00,000 2200000 11000000 Capital in excess of par 6000000 3000000 9000000 Retained earnings 24000000 -40,00,000 2,00,00,000 Net worth 4,00,00,000 4,00,00,000

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