Chapter 18, Problem 19P

a.

Summary Introduction

To show: The adjustments to be made in the capital account of Health Systems Inc. in order to pay a stock dividend of 15%.

Introduction:

Stock Dividend:

When a company pays dividend to its shareholders in the form of additional shares, it is termed as stock dividend. This form is generally paid when the company has less cash reserves.

Answer to Problem 19P

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

Explanation of Solution

The formula used for making the required adjustments to the capital account is shown below.

Working Notes:

Calculation of stock dividend in numbers:

$\begin{array}{c}\text{Stock Dividend}=\text{Shares Outstanding}\times 15\%\\ =6,000,000\times 15\%\\ =900,000\end{array}$

Calculation of additional capital in excess of par:

$\begin{array}{c}{\text{Capital in-excess of par}}_{\text{additional}}=\text{Stock Dividend}\times \left(\text{Market Price}-\text{Par Value}\right)\\ =900,000\times \left(\$32-\$10\right)\\ =900,000\times \$22\\ =\$19,800,000\end{array}$

Calculation of capital in excess of par:

$\begin{array}{c}{\text{Capital in-excess of par}}_{\text{at end}}={\text{Capital in-excess of par}}_{\text{at start}}+\\ {\text{Capital in-excess of par}}_{\text{additional}}\\ =\$35,000,000+\$19,800,000\\ =\$54,800,000\end{array}$

Calculation of the closing balance of the retained earnings account:

$\begin{array}{c}{\text{Retained Earnings}}_{\text{at end}}={\text{Retained Earnings}}_{\text{at start}}-\text{Transfer to common stock}-\\ \text{Transfer to capital in-excess of par}\\ =\$75,000,000-\$9,000,000-\$19,800,000\\ =\$46,200,000\end{array}$

b.

Summary Introduction

To show: The adjustments to be made to the EPS as well as stock price of Health Systems Inc., keeping the P/E ratio constant.

Introduction:

Earnings per share (EPS):

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

Stock Price:

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

Answer to Problem 19P

The EPS of Health Systems Inc. after stock dividend is $2.78 and the price of its stocks is $27.80.

Explanation of Solution

Calculation of the EPS of Health Systems Inc. after stock dividend:

$\begin{array}{c}{\text{EPS}}_{\text{after stock dividend}}=\frac{\text{Total Earnings}}{\text{Number of shares}}\\ =\frac{\$19,200,000}{\$6,900,000}\\ =\$2.78\end{array}$

Calculation of the price of stock:

$\begin{array}{c}\text{Price}=\text{P/E ratio}\times \text{EPS}\\ =10\times \$2.78\\ =\$27.80\end{array}$

Working Note:

Calculation of the number of shares after stock dividend:

$\begin{array}{c}{\text{Number of Shares}}_{\text{New}}={\text{Number of Shares}}_{\text{Old}}+\text{Stock Dividend}\\ =6,000,000+900,000\\ =6,900,000\end{array}$

c.

Summary Introduction

To calculate: The number of shares a shareholder would have if they originally owned 80 shares.

Introduction:

Stockholder:

Also called shareholders, people who own shares or capital stock in a corporation are known as stockholders. In other words, a shareholder is one who partly owns a company, that is, limited to the amount of shares owned.

Answer to Problem 19P

The number of shares that a shareholder originally holding 80 shares will after the declaration of stock dividend is 92.

Explanation of Solution

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

$\begin{array}{c}{\text{Number of Shares}}_{\text{After Stock Div}\text{.}}=\text{Original shares}+\left(\text{Original shares}\times 10\%\right)\\ =80+\left(80\times 15\%\right)\\ =80+12\\ =92\end{array}$

d.

Summary Introduction

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

Introduction:

Stock Dividend:

When a company pays dividend to its shareholders in the form of additional shares, it is termed as stock dividend. This form is generally paid out when the company has less cash reserves.

Answer to Problem 19P

With the P/E ratio remaining constant, the worth of the total investments of an investor before the declaration of stock dividend is $2,560 and that after the stock dividend is $2,557.60.

Explanation of Solution

Calculation of the value of an investor’s total investments before the declaration of stock dividend:

$\begin{array}{c}{\text{Total Investment}}_{\text{Before}}={\text{Shares Outstanding}}_{\text{Before}}\times {\text{Selling Price}}_{\text{Before}}\\ =80\times \$32\\ =\$2,560\end{array}$

Calculation of the value of an investor’s total investments after the declaration of stock dividend:

$\begin{array}{c}{\text{Total Investment}}_{\text{After}}={\text{Shares Outstanding}}_{\text{After}}\times {\text{Selling Price}}_{\text{After}}\\ =92\times \$27.80\\ =\$2,557.60\end{array}$

e.

Summary Introduction

To calculate: The worth of the total investments of an investor holding 80 shares after stock dividend.

Introduction:

Stock Dividend:

When a company pays dividends to its shareholders in the form of additional shares, it is termed as stock dividend. This form is generally paid out when the company has less cash reserves.

Answer to Problem 19P

The worth of the total investments, after stock dividend, of an investor who owns 80 shares of the company prior to the same is $2,944.

Explanation of Solution

Calculation of the value of an investor’s total investments after the declaration of stock dividend:

$\begin{array}{c}{\text{Total Investment}}_{\text{After}}={\text{Shares Outstanding}}_{\text{After}}\times {\text{Selling Price}}_{\text{After}}\\ =92\times \$32\\ =\$2,944\end{array}$

f.

Summary Introduction

To determine: Whether the investor is better off in the scenario given in part (e).

Introduction:

Stock Dividend:

When a company pays dividends to its shareholders in the form of additional shares, it is termed as stock dividend. This form is generally paid out when the company has cash reserves.

Answer to Problem 19P

Yes, the investor is better off in the scenario given in part (e).

Explanation of Solution

Since the cash dividend remains constant, the shareholder will receive more cash dividend along with a rise of $384 in the value of their portfolio of investments since 12 more shares at a value of $32 per share have been added.

g.

Summary Introduction

To calculate: The dividend yield on the stocks as per the scenario given in part (e).

Introduction:

Annual dividend yield:

Also termed as dividend price ratio, it is the ratio that helps compare the annual dividend of a company to its share price.

Answer to Problem 19P

The dividend yield for Health Systems Inc. on the stocks as per the scenario given in part (e) is 3.91%.

Explanation of Solution

Calculation of the dividend yield:

$\begin{array}{c}\text{Dividend Yield}=\frac{\text{Cash Dividend}}{\text{Market Price}}\times 100\\ =\frac{\$1.25}{\$32.00}\times 100\\ =\$3.91\%\end{array}$