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BONUS ISSUE A company can pay bonus to its shareholders either in cash or in form of shares. Many a times, a company is not in a position to pay bonus in cash inspite of sufficient profits because of unsatisfactory cash position or because of its adverse effects on the working capital of the company. In such case, if the company so desires and the articles of association of the company provide, it can pay bonus to its shareholders in the form of shares by making pertly paid shares as fully paid or by the issue of fully paid bonus shares.

Bonus Issue

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BONUS ISSUEy

A company can pay bonus to its shareholders either in cash or in form of shares. Many a times, a company is not in a position to pay bonus in cash inspite of sufficient profits because of unsatisfactory cash position or because of its adverse effects on the working capital of the company. In such case, if the company so desires and the articles of association of the company provide, it can pay bonus to its shareholders in the form of shares by making pertly paid shares as fully paid or by the issue of fully paid bonus shares.

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y The meaning of bonus shares : a premium or gift,

usually of stock, by a corporation to shareholders or an extra dividend paid to shareholders in a joint stock company from surplus profit.

EFFECT AND OBJECT OF BONUS ISSUEy

When a company accumulate huge profits and reserves, its balance sheet does not reveal a true picture about the capital structure of the company and the shareholders do not get fair return on their capital. Thus, if the Articles of Association of the company so permit, the excess amount can be distributed among the existing shareholders of the company by way of issue of bonus share.

THE EFFECT OF BONUS ISSUE IS TWO-FOLD ,VIZ.,y (1) It amount to reduction in the amount of

accumulated profits and reserve. y (2) There is a corresponding increase in the paid up share capital of the company.

THE BONUS ISSUE IS MADE TO ACHIEVE THE FOLLOWING OBJECTSy (1) To bring the amount of issued and paid up capital in line with the capital employed so as to depict more realistic earning capacity of the company. y (2) To bring down the abnormally high rate of dividend on its capital so as to avoid labour problems such as demand for higher wages and to restrict the entry of new entrepreneurs due to the attraction of abnormal profits. y (3) To pay bonus to the shareholders of the company without affecting its liquidity and the earning capacity of the company. y (4) To make the normal value and the market value of the shares of the company comparable. y (5) To correct the balance sheet so as to give a realistic view of the capital structure of the company.

ADVANTAGES OF ISSUE OF BONUS SHARESy (A) Advantages from the viewpoint of the company y (1) It makes available capital to carry an a larger and

more profitable business y (2) It is felt that financing helps the company to get rid of market influences. y (3) When a company pays bonus to its shareholders in the value of shares and not in cash, its liquid resources are maintained and the working capital of the company is not affected.

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y (4) It enables a company to make use of its profits on a permanent basis increases creditworthiness of the company. y (5) It is the cheapest method of raising additional capital for the expansion of the business. y (6) Abnormally high rate of dividend can be reduced by issuing bonus shares which enables a company to restrict entry of new entrepreneurs into the business and thereby reduces competition. y (7) The balance sheet of the company will reveal a more realistic picture of the capital structure and the capacity of the company.

ADVANTAGES FROM THE VIEWPOINT OF INVESTORS OR SHAREHOLDERSy It is generally said that an investor gains nothing from the issue of bonus shares. It is so because the shareholders receives nothing except some additional share certificates. But his proportionate ownership in the company remains unchanged. y (1) The bonus shares are a permanent source of income to the investors. y (2) Even if the rate of dividend falls, the total amount of dividend may increase as the investor gets the dividend on a larger no of shares. y (3) The investors can easily sell these shares and get immediate cash, if they so desire.

SOURCES OF BONUS ISSUESThe bonus shares can be issued out of the following : (1) Balance in the profit and loss account. (2) General Reserve. (3) Capital Reserve. (4) Balance in the Sinking Fund Reserve for Redemption of Debentures after the debenture have been redeemed. y (5) Development Rebate Reserve, Development Allowance Reserve, etc., allowed under the Income Tax Act 1961, after the expiry of the specified period(8yrs). y (6) Capital Redemption Reserve Account. y (7) Premium received in cash.y y y y y

WHAT DOES BUYBACK MEAN?y

The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies will buy back shares either to increase the value of shares still available (reducing supply), or to eliminate any threats by shareholders who may be looking for a controlling stake. y A share buy-back is the purchase by a company of its own shares in the market. These shares are usually then cancelled.y

WHY COMPANIES BUYBACK?y *Unused Cash: If they have huge cash reserves with

not many new profitable projects to invest in and if the company thinks the market price of its share is undervalued. y *Tax Gains Since dividends are taxed at higher rate than capital gains companies prefer buyback to reward their investors instead of distributing cash dividends, as capital gains tax is generally lower. At present, short-term capital gains are taxed at 10% and longterm capital gains are not taxed.

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*Market perception By buying their shares at a price higher than prevailing market price company signals that its share valuation should be higher. Eg: In October 1987 stock prices in US started crashing. y *Exit option If a company wants to exit a particular country or wants to close the company.y *Escape monitoring of accounts and legal

controls If a company wants to avoid the regulations of the market regulator by delisting. They avoid any public scrutiny of its books of accounts.

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y *Show rosier financials Companies try to use

buyback method to show better financial ratios. For eg. When a company uses its cash to buy stock, it reduces outstanding shares and also the assets on the balance sheet (because cash is an asset). y *Increase promoter's stake Some companies buyback stock to contain the dilution in promoter holding, EPS and reduction in prices arising out of the exercise of ESOPs issued to employees. Any such exercising leads to increase in outstanding shares and to drop in prices.

OBJECTIVES OF BUY BACK:Shares may be bought back by the company on account of one or more of the following reasons i. To increase promoters holding ii. Increase earning per share iii. Rationalise the capital structure by writing off capital not represented by available assets. iv. Support share value v. To thwart takeover bid vi. To pay surplus cash not required by business y Infact the best strategy to maintain the share price in a bear run is to buy back the shares from the open market at a premium over the prevailing market price. yy

ADVANTAGES OF BUY BACKy The advantage of buy-backs is that, by boosting the

share price, they give shareholders capital gains rather than income. y Another advantage of a share buy-back is that it gives shareholders more flexibility than a dividend as it allows shareholders to choose when, and if, to sell and realise their cash. This can also help minimise tax.y

WHAT ARE THE METHODS IN WHICH BUYBACK CAN HAPPEN?y Share buyback can take place in 3 ways:

1. Shareholders are presented with a tender offer where they have the option to submit a portion of or all of their shares within a certain time period and at usually a price higher than the current market value. Another variety of this is Dutch auction, in which companies state a range of prices at which it's willing to buy and accepts the bids. It buys at the lowest price at which it can buy the desired number of shares. 2. Through book-building process. 3. Companies can buy shares on the open market over a long-term period subject to various regulator guidelines like SEBI

RESOURCES OF BUY BACK

A Company can purchase its own shares from (i) free reserves; Where a company purchases its own shares out of free reserves, then a sum equal to the nominal value of the share so purchased shall be transferred to the capital redemption reserve and details of such transfer shall be disclosed in the balance-sheet or (ii) securities premium account; or (iii) proceeds of any shares or other specified securities. A Company cannot buyback its shares or other specified securities out of the proceeds of an earlier issue of the same kind of shares or specified securities.

SOURCES FROM WHERE THE SHARES WILL BE PURCHASEDy

The securities can be bought back from (a) existing security-holders on a proportionate basis; Buyback of shares may be made by a tender offer through a letter of offer from the holders of shares of the company or (b) the open market through (i). book building process; (ii) stock exchanges or (c) odd lots, that is to say, where the lot of securities of a public company, whose shares are listed on a recognized stock exchange, is smaller than such marketable lot, as may be specified by the stock exchange; or (d) purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.

VALUATION OF BUYBACK:There are two ways companies determine the buyback price. y They use the average closing price (which is a weighted average for volume) for a period immediately before to the buyback announcement. Based on the trend and value a buyback price is decided y In the 2nd, shareholders are invited to sell some or all of their shares within a set price range. The low point of the range is at a discount to the market price, while the top of the price range is set at a premium to the market price. Investors are given more say in the buyback price than in the above arrangement. Still this method is rarely used. Generally, the price is fixed at a mark up over and above the average price of the last 12-18 months.y

EFFECT OF BUYBACKS ON STOCK EXCHANGES:Buyback may leads to abnormal increase of prices posing heavy risk to those who value shares based on fundamentals. This may also lead to reduction in investor interest in the market particularly with de-listing of good shares. Eg: It was feared in 2001-03 that de-listing by many MNCs may drop the money flow to stock exchanges. y CONCLUSION y It may be remembered that buyback has no impact on the fundamentals of the economy or the company. Therefore investors should be cautious of unscrupulous promoters' traps.y

STOCK SPLITy A stock split is a way a company can lower its stock

price to make shares more affordable. It involves issuing shares on a pro-rata basis to existing stockholders. y : A stock split is essentially when a company increases the number of shares. y All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision by the company's board of directors to increase the number of shares that are outstanding by issuing more shares to current shareholders.

BENEFIT TO SHAREHOLDERS AFTER STOCK SPLIT AND BONUS ISSUEy Due to stock split, the high priced stocks will be

available at lower rates. The retailer or small investors can easily afford to buy stocks of low price. There is also a probability that after stock split; the stock price may go up as more investors may rush to buy stocks at lower rates. y Effect of stock split A stock split increases the number of shares in a public company. The price is adjusted such that the market capitalization of the company almost remains same.y

WHEN TO BUY STOCK SPLIT STOCK?y a) If you wish to get benefited from stock split then

you have to buy those stocks before record date. b) A company announces record date. c) If you buy those stocks before record date then you will be eligible for stock split. d) If you are not interested to buy stock after stock split where the stocks are available at lower rates.

DIVIDEND THEORIESThe term dividend refers to that part of profits of a company which is distributed by the company among its shareholders. It is the reward of the shareholders for investments by them in the share of the company. y DIVIDEND THEORIES :y (1) The Irrelevance Concept of Dividend or the Theory of Irrelevance, and y (2) The Relevance Concept of Dividend or the Theory of Relevancey

(1) THE IRRELEVANCE CONCEPT OF DIVIDEND OR THE THEORY OF IRRELEVANCEy These theories contend that there are two components y y y y y

of shareholders returns. a) Dividend Yield b) Capital Yield These theories, which argue that dividends are not relevant in determining the value of the firm, are: (A) Residual Theory ( Approach) (B) Modigliani and Miller Approach (MM model)

(A) RESIDUAL THEORY ( APPROACH)y

According to this theory, dividend decision have been no effect on the wealth of the shareholders or the prices of the shares, and hence it is irrelevant so far as the valuation of the firm is concerned. A firm will only pay dividends from residual earnings, that is, from earnings left over after all the suitable investment opportunities have been financed.

(B) MODIGLIANI AND MILLER APPROACH (MM MODEL)y

According to the model, it is only the firms investment policy that will have an impact on the share value of the firm and hence should be given more importance. They maintain that dividend policy has no effect on the market price of the shares and the value of the firm is determined by the earning capacity of the firm or its investment policy.

ASSUMPTION OF MM HYPOTHESISy The MM model of irrelevance of dividends is the y y y y y y

following assumption : (1) There are perfect capital markets. (2) Investors behave rationally. (3) Information about the company is available to all without any cost. (4) There are no floatation and transaction costa. (5) No investor is large enough to effect the market price of shares. (6) The firm has a rigid investment policy.

(2) THE RELEVANCE CONCEPT OF DIVIDEND OR THE THEORY OF RELEVANCEThe dividend is a relevant variable in determining the value of the firm, it implies that there exists an optimal dividend policy, which the mngrs should seek to determine, that maximises the value of the firm. There are three models, which have been developed under this approach. These are: y (a) Traditional Model y (b) Walter s Model y (c) Gordon s Dividend Capitalisation Modely

(A)TRADITIONAL MODELy MP is positively related to higher dividends. Thus MP

would increase if dividends are higher and decline if dividends are lower. y P = m (D + E/3) y where, where, P = Market price m = Multiplier D = Dividend per share E = Earnings per share

(B) WALTERS MODELBased on this model that all investments are financed through RE (Retained earnings ), rate of return and cost of capital are constant, the firm either distributes dividends or reinvested internally; Walter put forth the following model for valuation of shares y P=D + (E D) rlk k y P= market price per share = market price per share D = Dividend per share E = Earnings per share E D = Retained earnings per share r = Firm s average rate of return k = firm s cost o capital

(C) GORDONS DIVIDEND CAPITALISATION MODELy y y y y y y y

Myron Gordon has also developed a model on the lines of Prof. Walter suggesting that dividends are relevant and the dividend decision of the firm affects its value. His basic valuation model is based on the following assumption : (1) The firm is an all equity firm. (2) No external financing is available or used. Retained earnings represent the only sources of financing investment programmes. (3) The rate of return on the firm s investment r, is constant. (4) The firm has perpetual life. (5) Corporate taxes do not exist. (6) The cost of capital of the firm remains constant and it is grater than the growth rate.

Conty P = E 1 + (1

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b) + k br y where, P = Price per share at the end of the year, E = Earnings per share at the end of year, (1 b) = Fraction of earnings the firm distributes by way of earnings, b = Fraction of earnings the firms ploughs back, k = Rate of return required by the shareholders shareholders, r = Rate of return earned on investments made by the firm, br = Growth rate .