A profitable corporation has a current ratio in excess of one. The effect of recording a 100% stock dividend would be to: A. decrease the current ratio, earnings per share and return on equity. B. decrease the current ratio, and leave earnings per share and return on equity unaffected. C. leave the current ratio and return on equity unaffected and decrease earnings per share. D. leave the current ratio unaffected and decrease earnings per share and return on equity. Then answer is C. Why is there no impact on current ratio? Wouldn’t cash decrease by payment of dividends, so current assets would decrease?
It’s a stock dividend, not a cash dividend. Therefore, there is no change in cash position and no change in liabilities. Since a stock dividend does not affect equity (you still have the same amount before and after the dividend - the share price changes so that the MV of the firm remains the same), your amount of equity would not change either. However, issuing a 100% stock dividend would double the number of shares outstanding. Since Earnings per Share is Earnings / #Shares, increasing the denominator without increasing the numerator will LOWER this ratio.
Got it! Thank you.
I still don’t really understand why issuing more shares does not change ROE. Surely this would increase s/h equity? Ah - is it because retained earnings are all paid out as equity so you reduce all retained earnings and issue more shares but they cancel eachother out?
It is not a question about ROE - it is asking about Current Ratio. Current Ratio = Current Assets / Current Liabilities. A stock dividend has no impact on either of these numbers. It does affect the weighted number of shares outstanding therefore bringing down the EPS.
What about if a cash dividend was issued, then would that effect ROE?
ngilmore Wrote: ------------------------------------------------------- > It is not a question about ROE - it is asking > about Current Ratio. Current Ratio = Current > Assets / Current Liabilities. A stock dividend > has no impact on either of these numbers. It does > affect the weighted number of shares outstanding > therefore bringing down the EPS. What about the part of the answer that says “return on equity unaffected”? Anyway, I assume that’s because equity remains the same since 100% of NI (or retained earnings) moves to new common equity so shareholders equity remains the same.
JP_RL_CFA - Assuming it’s a profitable company (which the question says it is), a 100% cash divident would be paid by Net Income (i.e. retained earnings in shareholders equity) and not by cash assets so this would be a reduction in equity and an increase in liability (dividends payable). At this point ROE would be higher I think since you are dividing by a smaller amount of shareholders equity. I suppose this makes sense since you will be receiving a larger amount of return on your equity.
jdane416 Wrote: ------------------------------------------------------- > However, issuing a 100% stock dividend would > double the number of shares outstanding. Why the # of oustanding shares would double? A bit confused here.
100% Stock Dividend = 2:1 Split
That makes sense, thanks
To d11j0d: I think a 100% cash dividend might increase ROE since Equity will stay the same (as all of NI is paid out as dividends, addition to retained earnings is 0 and this equity will not change) so a higher net income divided by the same equity will increase ROE, no? Just my 2 cents.
Okay I just read what you wrote and it’s pretty much the same thing. cool !