Dryden, Corp. has 500,000 shares of common stock outstanding, a P/E ratio of 11, and $900,000 earnings
available for common stockholders.
The board of directors has just voted a 5:2 stock split.
a. If you had 100 shares of stock before the split, how many shares will you have after the split?
b. What was the total value of your investment in Dryden stock before the split?
c. What should be the total value of your investment in Dryden stock after the split?
d. In view of your answers to (b) and (c) above, why would a firm's management want to have a stock split?
a. Number of shares after split = 5/2 × 100 = 250
b. Earnings per share before split = $900,000
500,000 = $1.80
Price per share before split = 11 × $1.80 = $19.80
Total value of investment = $19.80 × 100 = $1,980
c. Total number of shares after split = 5(500,000)
2 = 1,250,000
Earnings per share after split = $900,000
1,250,000 = $.72
Price per share after split = 11 × $.72 = $7.92
Total value of investment after split = $7.92 × 250 = $1,980
d. 1. Stock splits are believed to have favorable information content. Splits are often associated with growth
companies. 2. Splits can conserve corporate cash if the firm has cash flow problems or needs additional funds for
attractive investment opportunities.
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