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solution

Health Systems Inc. is considering a 10 percent stock dividend. The capital accounts are as follows:

Common stock (4,000,000 shares at $10 par) $ 40,000,000
Capital in excess of par* 25,000,000
Retained earnings 45,000,000
Net worth $ 110,000,000

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

The company’s stock is selling for $45 per share. The company had total earnings of $12,000,000 with 4,000,000 shares outstanding and earnings per share were $3.00. The firm has a P/E ratio of 15.

a.What adjustments would have to be made to the capital accounts for a 10 percent stock dividend? Show the new capital accounts. (Do not round intermediate calculations. Input your answers in dollars, not millions (e.g. $1,230,000).)

b.What adjustments would be made to EPS and the stock price? (Assume the P/E ratio remains constant.) (Do not round intermediate calculations and round your answers to 2 decimal places.)

c.How many shares would an investor have if he or she originally had 90? (Do not round intermediate calculations and round your answer to the nearest whole share.)

d.What is the investor’s total investment worth before and after the stock dividend if the P/E ratio remains constant? (Do not round intermediate calculations and round your answers to the nearest whole dollar.);

e.Assume Mr. Heart, the president of Health Systems, wishes to benefit stockholders by keeping the cash dividend at a previous level of $1.05 in spite of the fact that the stockholders now have 10 percent more shares. Because the cash dividend is not reduced, the stock price is assumed to remain at $45.

What is an investor’s total investment worth after the stock dividend if he/she had 90 shares before the stock dividend?

f.Under the scenario described in part e, is the investor better off?

multiple choice

  • Yes

  • No

g.As a final question, what is the dividend yield on this stock under the scenario described in part e? (Input your answer as a percent rounded to 2 decimal places.)

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