The Chris Clapper Copper Company declared a 25 percent stock dividend on March 10 to shareholders of record on April 1. The market price of the stock is $50 per share. You own 160 shares of the stock.
a. If you sold your stock on March 20, what would be the price per share, all other things the same (no signaling effect)?
b. After the stock dividend is paid, how many shares of stock will you own?
c. At what price would you expect the stock to sell on April 2, all other things the same (no signaling effect)?
d. What will be the total value of your holdings before and after the stock dividend, all other things the same?
e. If there were an informational or signaling effect, what would be the effect on share price?
The Correct Answer and Explanation is:a. If you sold your stock on March 20, what would be the price per share, all other things the same (no signaling effect)?
Answer: $50 per share
Explanation: Since March 20 is before the record date of April 1, the stock is trading with dividend rights. This means any buyer purchasing the stock before April 1 is entitled to receive the 25% stock dividend. Therefore, the stock price on March 20 will still reflect the pre-dividend price of $50.
b. After the stock dividend is paid, how many shares of stock will you own?
Answer: 200 shares
Calculation:
25% of 160 shares = 0.25 × 160 = 40 new shares
160 + 40 = 200 shares
c. At what price would you expect the stock to sell on April 2, all other things the same (no signaling effect)?
Answer: $40 per share
Calculation:
New share price = $50 ÷ (1 + 0.25) = $50 ÷ 1.25 = $40
d. What will be the total value of your holdings before and after the stock dividend, all other things the same?
Answer: $8,000
Before dividend: 160 shares × $50 = $8,000
After dividend: 200 shares × $40 = $8,000
e. If there were an informational or signaling effect, what would be the effect on share price?
Answer: The share price may increase.
Explanation: In a perfect market with no signaling or informational effects, a stock dividend is purely cosmetic—it doesn’t change the overall value of your investment. You simply receive more shares at a proportionally reduced price. However, in the real world, stock dividends can signal positive information. For instance, a company issuing a stock dividend might be perceived as confident in its future earnings or growth. This perceived optimism can lead to increased investor demand, pushing the share price above the adjusted level post-dividend. In this case, instead of the price falling exactly from $50 to $40, it might drop to a higher level, such as $42, depending on market reactions. Thus, informational effects can lead to a net gain in shareholder wealth beyond the purely mathematical adjustment.
