It's July 1, 2018, and the market price of Warm Ways' common stock is $175 per share.

Question:

It's July 1, 2018, and the market price of Warm Ways' is $175 per share. There are 1.1 million common shares outstanding, and the Retained earnings account shows a balance of $45,000,000. Management wants to declare and pay a 20% but this would mean halting the company's cash payments because a 20% stock would cause retained earnings to fall by $38,500,000 (that is, 20% × 1.1 million shares × $175 per share). This would leave a balance of only $6,500,000, far below the $25,000,000 minimum required for cash dividends as specified in the company's loan agreement. It would take several years to build up retained earnings so that Warm
Ways could again pay cash dividends.
The chief financial officer of the company has proposed two ways to distribute common shares and still manage to pay cash dividends:
∙ Option A: Split the stock 12 for 10.
∙ Option B: Increase the size of the stock from 20% to 30%, and record the share as a stock split.
Required:
1. How will these two approaches affect the company's retained earnings?
2. As a common stockholder, would you prefer a 20% stock a 12-for-10 stock split, or a 30% stock Why?
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