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Hi, I am trying to find out whether a scrip issue will affect gearing. My book says it won’t, it reduces the value of the share, increases the number of shares and the value of equity is the same. The BPP book lists one of the advantages of a scrip dividend as “decreasing its gearing which can enhance its borrowing capacity”.
I searched online and found other information on this from Kaplan “Unless significant, a scrip issue will not dilute the share price. More shares reduce the company’s gearing and hence increase its borrowing capacity.” plus other Cima materials that say it will reduce gearing, and others that say it won’t.
I understand that theoretically it doesn’t change the value of equity but in the real world a small issue may do but that doesn’t help me as we no longer have the option to justify our answers in an exam. I really just need to know which approach Cima are taking on this for the exam and that’s difficult to find out with different books saying different things. Do you know how Cima want us to answer if asked about the effect of a scrip issue on gearing?
Hi,
It would depend on how the gearing is being measured and whether we are using book values or market values.
If we are using book values then there would be no impact on gearing as the share capital would increase and the share premium decrease.
If we are using market values then this is where the gearing may change as there are more shares in issue and therefore the market value of equity will increase, assuming that the individual share price has not fallen significantly, and gearing fall. Which is the focus of the Kaplan materials.
Hope this clears it up a bit and if it were to arise in the exam then I think it would be clear as to how gearing is being measured, and if not then I’d assume we are measuring it using market values.
Thanks
Thanks. It was questions with gearing calculated using market values that confused me. They don’t make it clear whether we should answer based on the theoretical price of the share after the issue or not. I think I’ll stick with the theoretical answer unless it’s obvious they don’t want that.
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