What is a DRIP as it applies to stocks? Suppose you own 5,000 shares of Rough Rider Disposal Inc. and the firm has a DRIP program. Rough Rider pays dividends at the rate of $1.50 per share per year and has a current price of $57 per share
How many additional shares of stock can you receive if you elect to receive your dividends via the DRIP option? What advantage over purchasing the stock on the open market does a DRIP plan offer?
What will be an ideal response?
Answer: A DRIP, or dividend reinvestment plan, is a technique that allows for the automatic reinvestment of cash dividends into the purchase of additional shares of the company's stock. In our example, the cash dividend for Rough Rider would be $1.50 per share × 5,000 shares for a total of $7,500. By selecting the DRIP option, you could purchase $7,500/$57 per share = 131.58 additional shares of stock. This option is popular because it allows for an easy way to increase stock ownership and typically eliminates the transaction costs an investor would bear in an open-market transaction. DRIPS, however, are not exempt from ordinary taxes on the receipt of dividends.
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