Introductory Corporate Finance: Dividend Policy - Stock Splits, Effect on Share Price Number of Shares Book Value Reverse Splits

What This Is

A stock split is a corporate action where a company divides its existing shares into a larger number of shares, typically to make the stock more affordable for individual investors. This can have a significant impact on the company's share price, number of shares outstanding, and book value. For example, if Tesla, Inc. (TSLA) has 100 million shares outstanding and a share price of $1,000, a 2-for-1 stock split would result in 200 million shares outstanding and a share price of $500.

Key Formulas & Models

• Stock Split Ratio (SSR) = Old Number of Shares / New Number of Shares – measures the ratio of old shares to new shares after a stock split.
  • Interpretation: SSR = 1:2 for a 2-for-1 stock split, SSR = 1:3 for a 3-for-1 stock split.
• New Share Price (NSP) = Old Share Price / SSR – calculates the new share price after a stock split.
  • Interpretation: NSP = $1,000 / 2 = $500 for a 2-for-1 stock split.
• Number of Shares Outstanding (NSO) = Old Number of Shares × SSR – calculates the new number of shares outstanding after a stock split.
  • Interpretation: NSO = 100 million × 2 = 200 million for a 2-for-1 stock split.
• Book Value Per Share (BVPS) = Total Equity / NSO – calculates the book value per share after a stock split.
  • Interpretation: BVPS = $10 billion / 200 million = $50 for a 2-for-1 stock split.
• Market Value Per Share (MVPS) = Market Capitalization / NSO – calculates the market value per share after a stock split.
  • Interpretation: MVPS = $200 billion / 200 million = $1,000 for a 2-for-1 stock split.
• Reverse Stock Split Ratio (RSR) = New Number of Shares / Old Number of Shares – measures the ratio of new shares to old shares after a reverse stock split.
  • Interpretation: RSR = 1:2 for a 1-for-2 reverse stock split, RSR = 1:3 for a 1-for-3 reverse stock split.
• New Share Price (NSP) = Old Share Price × RSR – calculates the new share price after a reverse stock split.
  • Interpretation: NSP = $500 × 2 = $1,000 for a 1-for-2 reverse stock split.
• Number of Shares Outstanding (NSO) = Old Number of Shares / RSR – calculates the new number of shares outstanding after a reverse stock split.
  • Interpretation: NSO = 200 million / 2 = 100 million for a 1-for-2 reverse stock split.

Step-by-Step Calculation

1. Determine the stock split ratio (SSR) or reverse stock split ratio (RSR).
2. Calculate the new share price (NSP) using the SSR or RSR.
3. Calculate the new number of shares outstanding (NSO) using the SSR or RSR.
4. Calculate the book value per share (BVPS) using the total equity and NSO.
5. Calculate the market value per share (MVPS) using the market capitalization and NSO.

Common Mistakes

• Mistake: Assuming a stock split increases the company's market capitalization.
  • Correction: A stock split only changes the number of shares outstanding and the share price, but not the market capitalization.
  • Counterexample: If Apple, Inc. (AAPL) has a market capitalization of $2 trillion and a 2-for-1 stock split, the market capitalization remains $2 trillion, but the number of shares outstanding increases to 4 billion.
• Mistake: Confusing a stock split with a reverse stock split.
  • Correction: A stock split increases the number of shares outstanding, while a reverse stock split decreases the number of shares outstanding.
  • Counterexample: If General Electric (GE) has 1 billion shares outstanding and a 1-for-2 reverse stock split, the number of shares outstanding decreases to 500 million.
• Mistake: Ignoring the impact of a stock split on the company's financial statements.
  • Correction: A stock split affects the number of shares outstanding, which can impact the company's earnings per share (EPS) and book value per share (BVPS).
  • Counterexample: If Microsoft (MSFT) has an EPS of $10 and a 2-for-1 stock split, the EPS remains $10, but the number of shares outstanding increases to 8 billion.

Exam / CFA Tips

• Tip: Be careful when calculating the new share price and number of shares outstanding after a stock split or reverse stock split.
• Tip: Understand the impact of a stock split on the company's financial statements, including EPS and BVPS.
• Tip: Be able to distinguish between a stock split and a reverse stock split.

Quick Practice Problem

A company has 100 million shares outstanding and a share price of $500. If it announces a 2-for-1 stock split, what is the new number of shares outstanding?

Answer: 200 million Explanation: The stock split ratio (SSR) is 1:2, so the new number of shares outstanding is 100 million × 2 = 200 million.

Last-Minute Cram Sheet

• Stock Split Ratio (SSR) = Old Number of Shares / New Number of Shares
• New Share Price (NSP) = Old Share Price / SSR
• Number of Shares Outstanding (NSO) = Old Number of Shares × SSR
• Book Value Per Share (BVPS) = Total Equity / NSO
• Market Value Per Share (MVPS) = Market Capitalization / NSO
• Reverse Stock Split Ratio (RSR) = New Number of Shares / Old Number of Shares
• New Share Price (NSP) = Old Share Price × RSR
• Number of Shares Outstanding (NSO) = Old Number of Shares / RSR
• A stock split does not change the company's market capitalization.
• A reverse stock split decreases the number of shares outstanding.
• A stock split affects the company's EPS and BVPS.