Financial Management

Posted: October 17th, 2013

Financial Management

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Financial Management

A stock split happens when a company decides to multiply its number of shares by a certain number in order to bring down the market price of its shares (Kimmel, Weygandt & Kieso, 2008). For instance, if a company wants to have its shares of stock selling at below $50, but the market price rises for the shares to around $100, the company could approve a 2-for-1-split, which would mean that the number of shares would be doubled. However, the size of the assets, liabilities and retained earnings will not change, as well as the number of shareholders. Therefore, this will not mean that shareholders wealth will be doubles as the shares are doubled. Rather, the number of their shares will double, but the value will remain the same since the price will be reduced by the same proportion (Kimmel, Weygandt & Kieso, 2008). In the example provided, it the company declared a 2-for-1 split, a shareholder with 1000 shares will have 2000 shares. 1000 shares will go at $100 before the split, making it $100,000 worth of stock. After the split, the shareholder will have 2000 shares, going for $50, thus, the value will remain the same, at $100,000 worth of stock. The point is usually to reduce the price of shares (Accounting Coach, 2012).

For XYZ Company, the split of 5-for-1 will result in the following way.

The price for common stock currently at par is $5.

Value of total shares $20,000,000

Number of shares == $20,000,000

$5

== 4,000,000 shares of common stock

In a split of 5-for-1, the number of shares will be multiplied by 5.

Resulting number of shares after the split == 4, 000, 000 × 5

== 20, 000,000 shares.

The price for each share after the split   == $ 20,000,000

20,000,000

== $1

The resulting stockholders’ equity section will look as shown below

Common stock ($ 1 par) == $20,000,000

Retained earnings            == $ 176,000,000

Total equity                     ==$ 196,000,000

After the split, the value of equity does not change, since the price of shares drops to $1, to maintain the value of shares even after the split. For a shareholder with 10,000, before the split they had a total value of $50,000. After the split, his number of shares multiplied by 5 to 50,000 shares. Their price dropped to $1, thus, keeping the value of his shares at $50,000.

References

Accounting Coach. (2012). Stock Splits and Stock Dividends. Retrieved from http://www.accountingcoach.com/online-accounting-course/17Xpg05.html#stock-splits-dividends

Kimmel, P.D., Weygandt, J.J. & Kieso, D.E. (2008). Accounting. Hoboken, N.J: John Wiley and Sons.