The Stock Dividend - Essay Example

The effect of a 15% stock dividend is to increase the number of shares by 15%. Hence, the new outstanding number of shares will be 1,200,000 x 1.15 = 1,380,000 shares. Hence, an additional 180,000 shares are added.
Since no new investment is obtained. The previous basis was $40 per share, thus $48,000,000 for the total shares outstanding. After the stock dividend, the basis will become 48,000,000 / 1,380,000 = $34.78 per share.

4 for 3 Stock Split
The total outstanding shares now become 1,200,000 / 3 x 4 = 1,600,000. The price per share will be 48,000,000 / 1,600,000 = $30 per share

Reverse 3-for-1 Stock Split
For a reverse 3-for-1 stock split, the number of shares will be decreased. Hence, the new outstanding number of shares will be 1,200,000 / 3 x 1 = 400,000 shares.
The price will increase to 48,000,000 / 400,000 = $120 per share.

Hudson Homes and Baldwin Construction
Return on Equity (ROE) is given as Net Income / Total Equity.
If net income is the same for both companies ($1 million) and so are the assets ($10 million each), the variation in the ROE (11.1% for Hudson and 20% for Baldwin) is attributed to the difference in the liability structure of the two companies.
Also, the above figures for ROE show that Hudson’s equity is more than Baldwin's equity, thus Hudson’s ROE is less than Baldwin’s.
Since, equity = assets – liabilities. Hence, if Hudson’s equity is high, its liabilities must be lesser than the other company's. Calculations are shown below:
Hudson Homes
ROE = 11.1%
Net income = $ 1 million
Hence, Equity = Net Income / ROE = $9,009,009
Since, assets = $10 million
Hence, Liabilities = 10,000,000 – 9,009,009 = $990,991
Baldwin Construction
ROE = 20%
Net income = $ 1 million
Hence, Equity = Net Income / ROE = $5,000,000
Since, assets = $10 million
Hence, Liabilities = 10,000,000 – 5,000,000 = $5,000,000

As shown above, Hudson’s liabilities are lesser than Baldwin’s which is why there is a difference in equities between the two companies and hence the difference in return on equity.

The model takes into account the dividend growth rate and price growth rate to arrive at the expected future price of stock security.

The practical adjustments that might be required include a better estimation of the stock price through the market-based valuation of the stock. In addition, the market behavior of the stock must also be considered to arrive at its fair price.

In an efficient equity market, though there is a lesser probability of a mid-priced stock and hence a lesser probability of generating abnormal rates of returns; however, a financial analyst’s job does not only have to deal with generating higher margins on the stock.

In addition, he/ she would be responsible to diversify risks in investing in a range of securities and keeping a low-risk yet reasonable return portfolio. In reality, in an efficient equity market, the requirements for a well-trained and intelligent financial analyst are higher than in an ordinary market where anyone can make money.

However, earning higher returns in an efficient market requires a well-thought strategy and experience, and hence, a financial analyst’s job becomes much more rewarding in these circumstances.