Concept Of Reverse Stock Splits

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The company may want to reduce the number of share outstanding if its share price falls substantially. Number of share is reduced by reverse stock split. The reduction of the number of outstanding share increases both the par value per share and market price per share. Reverse stock split also increases earning per share and dividend per share. It is just opposite of stock splits.

Example,

Suppose, total shareholder's account of a firm is as follows:

A. Common stock (10,000 Shares @ $ 10).........................= $ 100,000
B. Additional paid in capital...................................................= $ 100,000
C. Retained earnings..............................................................= $ 300000
Total shareholder's equity....................................................= $ 500,000

Now let us assume that the firm announced 2-for-5 reverse stock split, which results into decrease in number of outstanding shares from 10,000 shares to 4,000 shares (i.e. 10,000 shares x 2/5) and increase in the par value from $10 per share to $ 25 per share ( i.e. $10 x 5/2). This keeps the value of common stock constant at $ 100,000 ( i.e. 4,000 x $25). Thus, total shareholder's equity account of the firm after 2-for-5 reverse stock splits appear as:

A. Common stock (4,000 shares @ $25 each).......................= $ 100,000
B. Additional paid in capital .....................................................= $ 100,000
C. Retained earnings ................................................................= $ 300,000
Total shareholder's equity (A+B+C)......................................= $ 500,000.

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