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Dear professional John.
get dizzy and so mess up with my brain……
somehow, I don’t know understand the reason the decrease in Gearing on the normal basis will be in a scrip issue(bonus issue) with perfect information.
how could the gearing be affected by bonus issue?
the issue doesn’t make equity decline and raise debt in my knowledge.
could you possibly Fix my logic please sir!
many thanks
Because the question mentions perfect information, it suggests that gearing is to be measured using the market values of equity and debt.
A bonus/scrip issue will not affect the gearing – shareholders will have more shares, but the market value per share will be lower. The total market value will stay the same.
However, if it is a scrip dividend (i.e. giving shares as dividend instead of a cash dividend), then the market value of equity will be higher than if it had been a cash dividend, and then the gearing will be lower than if they had paid a cash dividend.
I’ll leave the whole question. sir.
Which of the following statements is true of a scrip issue with perfect information?
1. Decreases earning per share
2. Decreases the debt/equity ratio of the company.(calculated on a market value basis)
3. Increases individual shareholder wealth.
4. Increases the market price of the share.Answer: 1.
i have no doubt for the answer “1”
but in the answer sheet, it is written that
The debt/equity value on a nominal value basis would fall but as the total market value of the shares will be unaffected, the market value gearing would be unaffected.
what do they mean by ” the debt /equity value on a nominal value basis would fall”?
This is the question referring to a scrip issue other than scrip dividend sir.
sorry for the lack of knowledge to understand your kind explanation. sir.
Now you have typed the whole question, it makes sense 🙂
As I wrote before, and as the answer says, if the gearing is measured on market values then a bonus issue does not affect the gearing.
However if nominal values are used (rather than market values), then the nominal value of the shares will increase (because of more shares in issue) and therefore the gearing will fall.
But in fact, normally if we are not using market values then we use book values, and the book value of equity is share capital plus reserves. A bonus issue will not change the book value of equity (share capital increases and reserves decrease) and so the gearing stays the same.
Anyway, all of that is irrelevant because choice 2 specifically says ‘decrease gearing on a market value basis’ – and that is not correct for the reason I wrote in my previous reply 🙂
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