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On page 264 BPP textbook F9, one of Advantages of scrip dividends is “A share issue will decrease the company’s gearing, and may therefore enhance its borrowing capacity”.
I doubt the validity of this advantage, as scrip dividends do not make change to equity, and gearing ratio = long-term debt/(long-term debt + equity) therefore gearing does not alter.
Please help me to verify this advantage
Thank you!It could perhaps have been worded a little better.
Paying a cash dividend does increase the gearing (retained earnings are lower and therefore the equity (share capital plus reserves) is lower).
However if there is a scrip dividend then retained earnings fall and share capital increases, so the gearing remains the same (but is lower that it would have been if there had been a cash dividend).Thanks John, eish you saved me. I came across it in Kaplan and I searched everywhere for an explanation, Google, YouTube you name it, but I found none. Now it’s making sense.
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