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Stock and Cash Dividends

You are the holder of common stock in ABS, Inc. Historically, the firm has paid generous cash dividends. The firm recently announced that it would replace its cash dividend with a 20 percent annual stock dividend.

Answer the following:

a) Is this good news, bad news, or is it impossible to tell from the information provided? Explain the reason for your answer.
b). Why do many firms choose to issue stock dividends?
c). What is the value of a stock dividend?

Please provide a thorough, qualitative answer.

Solution Preview

Before you answer this question, the first thing that you may want to do is make a distinction between what is a cash dividend and what is a stock dividend. Cash dividends may be described as a portion of the earnings of a company that are paid out to its shareholders based on the number of shares that that shareholder has in the company. So for example, if ABS, Inc. pays a dividend of $0.05 per share, and a shareholder owns 100 shares in ABS, Inc., then that shareholder would receive $5.00 as dividend payment (which is subject to tax). A stock dividend on the other hand, includes issuing additional shares to shareholders, instead of paying out cash. Take for example, in the question given, ABS Inc. has decided to make a annual 20% stock dividend - what this means is that for a shareholder who owns 100 shares, at the end of a company's financial year he/she will get an additional 20 shares. Also, if the company had 1,000,000 shares prior to the stock dividend announcement, after the 20% stock dividend, the company will have 1,200,000 shares outstanding at the end of its financial year.

Whether it is good news or bad news if ABS Inc. decides to make a stock dividend depends on a number of factors. The fact that ABS ...

Solution Summary

This solution provides you with information as to - what is a cash dividend and what is a stock dividend (with examples of each); whether it is good or bad for a firm to replace its cash dividend with stock dividend; and the reasons for why firms issue stock dividend.

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