Question

Candela Company has retained earnings of $500,000, common stock of $400,000, and total common stockholders’ equity of $1,200,000. It has 200,000 shares of $2 par value commonstock outstanding which is currently selling for $5 per share. If Candela Company declares a 2-for-1 stock split on its common stock, which of the following will occur?
1) Retained earnings will decrease by $1,000,000.
2) There will be no effect on total common stockholders' equity.
3) Net income will increase by $1,000,000.
4) Total paid-in capital will increase by $1,000,000

Answer 1

Answer:

2) There will be no effect on total common stockholders' equity.

Explanation:

Step 1: Determine liabilities

This can be expressed as;

E=A-L

where;

E=Common stockholders equity

A=total assets

L=total liabilities

In our case;

E=$1,200,000

A=500,000+(5×200,000)=500,000+1,000,000=$1,500,000

L=unknown

replacing;

1,200,000=1,500,000-L

L=1,500,000-1,200,000=$300,000

Total liabilities=$300,000

Step 2: Determine current asset value

After 2 for 1 split;

shares after split=200,000×2/1=400,000

price after split=5×1/2=$2.5

Current asset value=(400,000×2.5)+500,000=$1,500,000

Step 3: Determine equity after split

Equity after split=1,500,000-300,000=$1,200,000

The stockholders equity after split=$1,200,000

The stockholders equity after the 2-for-1 split remains the same.