## Thursday, October 06, 2011

### Dilutive Effect of Splits and Dividends

CFA Level 1 - Financial Ratios

Since in the Financial Statements section we described stock dividends and splits, here we will focus on their effects by considering an example.
Example 1: Cash Dividend
In 2004, Company ABC generated a net income of \$12 million and paid a dividend of \$1 million to preferred stockholders.

Other information:

The first step is to average out the number of months the shares were outstanding:

Answer: Basic EPS = \$12 million - \$1 million / 3.8 million = \$2.89

Example 2: Stock Splits and Dividends
Stock splits and dividends are applied to all shares issued prior to the split and to the weighted average number of shares at the beginning of the period. In other words, if in this quarter a company declares a 2-to-1 stock split, then double the number of outstanding shares of prior months.

Furthermore, if the company declares in Q3 a stock dividend of 10%, then increase the number of shares outstanding by 10% of prior months. Shares that are repurchased from treasury after the stock split and dividends should not be adjusted.

Other information:

The first step is to account for the stock dividend in Q3:

The second step is average out the number of month the shares were outstanding:

Answer: Basic EPS = \$12m -\$1m/ 4.28m = \$2.57
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