Company Z\'s stock trades at $45 a share. The company is contemplating a 3-for-2
ID: 2637986 • Letter: C
Question
Company Z's stock trades at $45 a share. The company is contemplating a 3-for-2 stock split. Currently, the company has EPS of $3.00, DPS of $0.50, and 20 million shares of stock outstanding. Assuming that the stock split will have no effect on the total market value of its equity, what will be the company's stock price following the stock split?
a. How many shares of stock will be outstanding after the split?
b. Calculate EPS after the split.
C. Calculate DPS after the split.
D. Calculate price per share after the split
e. Calculate price after the split if the PE increases by 2 points (for example, if PE was 10 prior to split, it increases to 12 after the split)
f. Why do companies split their stock? Why might a split cause the P/E to increase?
Explanation / Answer
Outstanding shares before split = 20 millions shares
a. No. of shares after split= 20*3/2
=30 millions sahres
Total Earning = 3*20 millions
= 60 millions shares
b. EPS after split = total earning/ No of shares after split
= 60/30
= $2/shares
Total Dividend before split =0.50*20 millions
= 10 millions shares
c. Total Dividend after split = $10millions/30millions shares
=$0.333/shares
Total market value = $ 45/shares *20 millions shares
=$ 900 millions
d. Market shares after split = $900 millions/30 millions
=$30/shares
Price earning ratio before split = MPS/EPS
= 45/3
=15 times
e.If Price earning ratio increases by 2 times then, new P/E ratio will be 17 times.
so, new market price after split is $34/shares (17*2).
f. Company should split their shares to reconstruct the capital structure of the company. After splitting P/E ratio will be rise as market price will be decline.
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