Rough Rider Disposal Inc. is having a stock split. The current price is $57 per share, and you own 500 shares. The split is a one-and-one-half-shares-for-one share split. What is the expected per share price after the split?
What is your wealth before and after the split? Based on empirical evidence, does the market value of outstanding shares (new price times new quantity) tend to increase or decrease on average when stocks split into a greater number (but lower priced) shares, as in this problem?
What will be an ideal response?
Answer: The price should drop from $57 per share to $57/1.50, or $38 per share. Your wealth should not change. Your pre-split value was $57 × 500 shares = $28,500. After the split, you have 500 shares × the split ratio of 1.5 = 750 shares. Your post -split wealth is $38 × 750 shares = $28,500. There is no change in your wealth. However, empirical evidence does indicate that stock splits are a positive signal in the marketplace and on average result in increased wealth to shareholders. Of course, individual results may vary.
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