Page 311 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 14: Management of Surplus & Dividend Policy

Self Assessment Notes

Fill in the blanks:
7. Walter’s Model supports the doctrine that dividends are ……………..
8. Gordon Model assumes that future dividends are the sole determinant of the …………..value
of the common shares.
9. According to ………………….model, there would be no impact of the dividend declaration
on the market price of the share so long as it is at the expected rate.

14.4 Forms of Dividends

In addition to cash dividends, the firm has other options for distributing profits to shareholders.
These options are:

1. Bonus shares (stock dividend)
2. Stock (share) split
3. Stock repurchase

14.4.1 Bonus Shares (Stock Dividend)

Bonus shares occur when new shares are issued on a pro rata basis to the current shareholders
while the firm’s assets, its earnings, the risk being assured and the investor’s percentage
ownership in the company remain uncharged.

Example: If a shareholder owns 100 shares of common stock at a time when the firm
distributes bonus shares in the ratio of 1:20 (1 share for every 20 shares held), the shareholder
will receive 5 additional shares.
There are several favourable aspects of a bonus issue:
1. Conserves cash: The stock dividend (bonus shares) allows the firms to declare a dividend
without using up cash that may be needed for operations or expansion.
2. Indicates higher future profits: Normally a bonus share is an indication of higher future
profits.
3. Raises future dividends for investors: If the regular cash dividend is continued after the
bonus issue, the individual shareholder will receive higher total dividends.

4. Has high psychological value: Because of the positive aspects of bonus shares, issue of
bonus shares receives positive response by the market.
5. Retains proportional ownership for shareholders: It helps the majority shareholders in
retaining the proportional ownership as compared to rights issue of shares where the
shareholders are expected to pay for the shares including the premium as per issue criteria.

14.4.2 Stock (Share) Split

A stock split is a change in the number of outstanding shares through a proportional reduction
or increase in the par value of the shares. Only the face value (par value) and number of
outstanding shares are affected. The market price of the stock will adjust immediately to reflect
the stock split. Example: a firm may have 20,00,000 outstanding shares selling for 20 per share.

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