Chapter 18, Problem 18P

a.

Summary Introduction

To show: The adjustments to be made in capital accounts of Ace Products in order to payout a stock dividend of 10%.

Introduction:

Stock Dividend:

When a company pays dividends to its shareholders not in cash but in the form of additional shares, such a dividend is termed as stock dividend. This form is generally paid out when company falls short of cash.

Answer to Problem 18P

The adjustments that would be made to the capital account for payment of 10% stock dividend are as follows:

Explanation of Solution

The calculation used for making required adjustments to capital account is shown below:

Working Notes:

Calculation of Stock Dividend in numbers:

$\begin{array}{c}\text{Stock Dividend}=\text{Shares Outstanding}\times 10\%\\ =2,400,000\times 10\%\\ =240,000\end{array}$

Calculation of additional capital in-excess of par:

$\begin{array}{c}{\text{Capital in-excess of par}}_{\text{additional}}=\text{Stock Dividend}\times \left(\text{Market Price}-\text{Par Value}\right)\\ =240,000\times \left(\$20-\$5\right)\\ =240,000\times \$15\\ =\$3,600,000\end{array}$

Calculation of Capital in-excess of par:

$\begin{array}{c}{\text{Capital in-excess of par}}_{\text{at end}}={\text{Capital in-excess of par}}_{\text{at start}}+\\ {\text{Capital in-excess of par}}_{\text{additional}}\\ =\$5,000,000+\$3,600,000\\ =\$8,600,000\end{array}$

Calculation of closing balance of retained earnings account:

$\begin{array}{c}{\text{Retained Earnings}}_{\text{at end}}={\text{Retained Earnings}}_{\text{at start}}-\text{Transfer to common stock}-\\ \text{Transfer to capital in-excess of par}\\ =\$23,000,000-\$1,200,000-\$3,600,000\\ =\$18,200,000\end{array}$

b.

Summary Introduction

To show: The adjustments to be made to the EPS as well as the stock price of Ace Products, assuming the P/E ratio to remain the same.

Introduction:

Earnings per share (EPS):

It is the profit earned by shareholders on each share. A higher EPS indicates higher value of the company because investors are ready to pay higher price for one share of the company.

Stock Price:

The highest price of one share of a company that an investor is willing to pay is termed as the stock’s price. It is current price used for the trading of such share.

Answer to Problem 18P

The EPS of Ace Products after stock dividend is $1.82 and the price of its stocks is $18.20.

Explanation of Solution

Calculation of the EPS of Ace Products after stock dividends:

$\begin{array}{c}{\text{EPS}}_{\text{after stock dividend}}=\frac{\text{Total Earnings}}{\text{Number of shares}}\\ =\frac{\$4,800,000}{\$2,640,000}\\ =\$1.82\end{array}$

Calculation of the price of stock:

$\begin{array}{c}\text{Price}=\text{P/E ratio}\times \text{EPS}\\ =10\times \$1.82\\ =\$18.20\end{array}$

Working Note:

Calculation of Number of shares after stock dividend:

$\begin{array}{c}{\text{Number of Shares}}_{\text{New}}={\text{Number of Shares}}_{\text{Old}}+\text{Stock Dividend}\\ =2,400,000+240,000\\ =2,640,000\end{array}$

c.

Summary Introduction

To calculate: The number of shares a shareholder would have if he originally owns 70 shares.

Introduction:

Stockholder:

Also termed as a shareholder, the person who own shares or capital stock in a corporation is the stockholder. In other words, a shareholder is the one who partly owns a company, limited to the amount of his shares.

Answer to Problem 18P

The number of shares that a shareholder originally holding 70 shares will after the declaration of stock dividend have 77 shares.

Explanation of Solution

Calculation of the number of shares of one of the shareholders after stock dividend:

$\begin{array}{c}{\text{Number of Shares}}_{\text{After Stock Div}\text{.}}=\text{Original shares}+\left(\text{Original shares}\times 10\%\right)\\ =70+\left(70\times 10\%\right)\\ =70+7\\ =77\end{array}$

d.

Summary Introduction

To calculate: The worth of the total investments of an investor before as well as after the stock dividend, the P/E ratio being constant.

Introduction:

Stock Dividend:

When a company pays dividends to its shareholders not in cash but in the form of additional shares, such a dividend is termed as stock dividend. This form is generally paid out when company falls short of cash.

Answer to Problem 18P

The P/E ratio remaining constant, the worth of the total investments of an investor before the declaration of stock dividends is $1,400 and after the stock dividend is $1,401.

Explanation of Solution

Calculation of the value of an investors total investments before the declaration of stock dividends:

$\begin{array}{c}{\text{Total Investment}}_{\text{Before}}={\text{Shares Outstanding}}_{\text{Before}}\times {\text{Selling Price}}_{\text{Before}}\\ =70\times \$20\\ =\$1,400\end{array}$

Calculation of the value of an investors total investments after the declaration of stock dividends:

$\begin{array}{c}{\text{Total Investment}}_{\text{After}}={\text{Shares Outstanding}}_{\text{After}}\times {\text{Selling Price}}_{\text{After}}\\ =77\times \$18.20\\ =\$1,401\end{array}$