1 sandeep gokhale. 2 references financial management authors : khan & jain prasanna chandra...
TRANSCRIPT
1
Sandeep Gokhale
2
References
Financial Management
Authors :• Khan & Jain• Prasanna Chandra• Myers• Van Horne
3
Syllabus
• Ratio Analysis• Fund & Cash flow analysis• Cost of Capital• Working Capital Mgmt.• Means of Financing• Capital Budgeting• Dividend Structuring• Bonus Shares• Share Holder Value
Measurement
4
FINANCIAL MANAGEMENT
Objective: Create share holder value
Methodology: Capturing of value at all Levels.
Business Process restructuring
Enterprise resource management.
Vertically integrated operations.
Customer relationship Management
Sustained up scaling of operations
Effectiveness: Proximity of gross profit to net profit
Maximisation of EVA
EV / EBIDTA multiple
5
Financial Management – an Overview
Business environment
Planning Policies&Decisions
(Management Accounting)
Restructuring
Resource Mobilisation
Treasury
Control&Information
( Audit & Taxation)
Valuation Technique
Financial Markets
Investor Wish List
6
Environmental scan
Economy: Convertibility of Local Currency
GDP / Industrial growth rate
Scalability of Operations
FDI – Incoming / outgoing
Inflation rate / Fiscal deficit
Trade surplus/deficits
Balance of payment status
WTO Implications
Emerging markets scenario
Gross national income distribution
7
Government Policy: Industrial policy
Government programmes and projects
Tax regime
Subsidies, incentives and concessions
Exim policies / VAT
Government Expenditure
Lending considerations of financial institutions and commercial banks
Infrastructure Development
Rating of Govt paper
Agricultural policies
8
Technology: Emergence of new technologies.
Access to technical Up gradation
Level of obsolescence.
Socio Demographic: Population trends
Age shifts in population
Educational profile.
Attitudes toward consumption and investment
9
Competition: Number of players in the industry and their market share.
Duty barrier and status of international cost and volume positioning.
Degree of homogeneity and differentiation among products.
Entry barriers for new capacities.
Comparison with substitute products.
Unorganised sector operations.
Marketing polices and practices.
10
ORGANISATIONAL INTERFACE OF FINANCE
Areas Interface
Corp planning: Long term financial goals in terms of assets, sales,profits,dividends etc.
Expansion, new projects diversifications
takeovers , mergers,disinvestments.
Internal generation, tax planning.
Operations: Integrating functional plans.
Working capital management
11
Areas Interface
Control: Budgetary control of all divisions
Variance analysis
Marketing: Credit norms
Cost analysis of decisions like discounts , premium pricing,product promotion etc.
Manufacturing: Budgeting for manufacturing operations.
Product mix decisions.
Personnel: Budgeting for personnel & administrative function.
12
FINANCIAL FUNCTION
Money Mgmt Accounting Control Advisory Role
Resource Mobilisation
Financial Accounting
Budgets Project Financing
Working Capital Mgmt
Cost Accounting
Variance Analysis
Pricing
Investment
Mgmt
Mgmt Accounting
Profit Center Div. Policy
Valuation of Assets
Cost Center
13
Financial Decision Areas
• Investment analysis• Working capital management• Sources and cost of funds• Determination of capital structure• Dividend policy• Analysis of risks & returns• Treasury - interest / exchange rate swaps• Restructuring of operations / term debt profile• Equity buyback / Bonus / Capitalisation
• To result in shareholder wealth maximisation
14
PROFIT AND LOSS ACCOUNT
For the Period 1st April to March 31st
Income:Gross sales from Goods & Services
Less: Excise Duty
Net Sales
Other Income
Non operating Income
Total Income
15
Expenditure: Raw materials consumed
Manufacturing expenses
Administrative expenses
Selling expenses
WIP +FG adjustment
PBIDT (Gross Profit)
Less: Interest
Less Depreciation
PBT (Operating Profit)
Less: Tax
PAT (net profit)
Gross cash accruals : PAT + Depn
Net cash accruals : GCA - Dividend
16
THE BALANCE SHEET
For the year ended March 31st 200...
Liabilities: Equity share capital
Reserves & Surplus
Term loan
Debentures
Fixed deposits
Other unsecured loans
Commercial bank borrowings
Creditors
Other current liabilities
17
Assets: Gross fixed assets
Less: Acc. Depn
Net Block
Investments
Currents Assets: RM Stock
WIP
F.G.Stock
Debtors
Cash in bank
Loans & Advances
Misc.. expenditure
Deferred expenditure
18
RATIO ANALYSIS
Principal tool for analysis
Inter firm comparison
Intra firm comparison
Industry analysis
Responsibility accounting
19
TYPES OF FINANCIAL RATIOS
Liquidity
Leverage
Turnover
Profitability / Valuation
20
LIQUIDITY RATIOS
Current Ratio: Current assets
Current liabilities
Acid test ratio: C.A- Inventories
Current liabilities
Cash position ratio: Cash in bank + hand
Current liabilities
Inventory to G.W.C: Inventory
Current assets
21
LEVERAGE RATIOS
Debt / Equity ratio: Long term debt
Net worth
Borrowing / Assets: 1 - Net worth
Total Assets
Fixed asset / Networth: Fixed Assets
Net worth
22
Capital gearing ratio: Capital entitled to fixed return
Capital not entitled to fixed return
Debt. Service coverage ratio: PBDIT - Tax
Interest + Annual installment
Interest coverage ratio: PBDIT - Tax
Interest
F. Asset coverage ratio: Gross fixed asset - Acc. Depn
LT Secured liabilities
23
ACTIVITY RATIOS
Total asset turnover: Net sales
Total assets
Fixed asset turnover: Net sales
Fixed assets
Inventory turnover: Net sales
Inventory
24
Debtors turnover: Credit sales
Avg. debtor
Collection period: Avg. debtor * 365
CR. Sales
Creditors Turnover: Credit purchase
Avg.. Creditors
Payment period: Avg. Creditor * 365
Net Purchases
25
PROFITABILITY / VALUATION RATIOS
Gross profit ratio: PBDIT / Sales
EBITDA / Sales
RONW : PAT / Networth
ROSE: PAT - Pref. Div
Net worth
Return on CAP. Employed: PBIT
Total Lia - Creditors – Provisions
Return on Investment : PBIT / Investments
26
Book value per share: Net Worth
NO of Equity Shares
EV / EBITDA: Enterprise value / Gross profit
Earning per share: PAT - Pref Div
No. of Equity shares
Price Earning ratio: Market price
Earnings per share
Pay out ratio: Dividend paid
Profit after Tax
27
USERS OF FINANCIAL RATIOS
Lenders of funds for appraising credit worthiness for long term / short term lending decisions.
Valuations in investment / disinvestment decisions.
Financial analyst / Mutual Funds / Investment Bankers.
Management for operational short / long term planning.
Credit Rating Agencies
Tax authorities
28
LIMITATIONS OF RATIO ANALYSIS
A ratio in absolute terms has no meaning. It has to be compared.
•Inter firm comparison.
•Companies resort to window dressing of Balance sheets.
•Operating and accounting practices differ from company to company.
•Consolidation of group / subsidiary companies figures.
E.G. Changes in Depreciation methods
Inventory Valuation
Treatment of contingent liabilities.
Valuation of investments.
Conversion or transaction of foreign exchange items.
29
FUND FLOW ANALYSIS
It is a statement indicating the methods by which a company has been financed and the uses to which it has applied its funds over a period of time.
It provide an insight into the movement of funds and helps in understanding the changes in the structure of asset & liabilities.
Provides information as to how funds are raised and utilised.
Determines need for funds and helps in deciding finance mix
Determines financial consequences of business decisions.
Free cash flow generation ability and Utilisation of the same.
30
FUND MANAGEMENT
Mobilisation Requirement
Quantum Source Cost
Normal Capital
expenditure
IncrementalWorking capital
New Investments
Equity Buy back
31
FUND FLOW OCCASIONS
Sources Uses
Funds from operations Loss from operations
Sale of fixed assets Increase in fixed assets
Increase in liabilities Redemption of liabilities
Sale of securities Purchase of securities
Decrease in W.C Increase In W.C
Cash Dividends, Equity buy back
32
FUND FLOW
Assets Uses of funds
Liabilities Uses of funds
Assets Source of funds
Liabilities Source of funds
Comparison of balance sheets of consecutive years.
33
TYPES OF FUND FLOW STATEMENTS
OVERALL FUND FLOW
OPERATIONAL FUND FLOW
WORKING CAPITAL BASED FUND FLOW
(ONLY STS/STU STATEMENT)
34
COST OF CAPITAL
Aggregate of the liabilities raised by a company is the total capital employed in business.
Different sources have different cost and tax implications.
Cost of capital
It is a single rate (weighted average ) for a finance mix.
It is computed on a post - tax basis since cost of different sources
have different tax implications
E.g.. Interest on debt capital enjoys tax shield while dividend paid
on equity has no tax shield.
COC is used as a discounting rate in DCF analysis.
35
RELEVANCE OF COC
•Used as a hurdle rate in DCF analysis.
•Wt. Average cost of capital
•Marginal cost of capital
K0 = Ki + Ke
K0 = WT. Average cost of capital
Ki = Cost of debt capital
Ke = Cost of equity capital
36
COST OF CAPITAL
Consists of three components:
•Risk less cost of a particular type of finance (rj)
•Business risk premium(b)
•Finance risk premium(f)
K0 = rj + b + f
37
RELATIONSHIP BETWEEN WEIGHTED AVERAGE COST AND MARGINAL COST OF CAPITAL
•Degree of leverage
•Cost of instruments
•Tax Rate / Treatment
WACOC : K0 = Ki1 + Ke1
MCOC : K0 = Ki2 + Ke1
38
METHODS OF COMPUTATION OF COST OF EQUITY
ROI approach
Ke = PAT - pref. div + non tax shield portion of depn
Equity block (E + R +S + acc depn)
Market capitalisation approach
Ke = D/P + G
D = Dividend per share G = Growth rate = b*r
P = Market price per share
b= % Retained earnings = PAT - Dividends / PAT
r = % Return on “b” = PAT - Pref div / Net worth
39
Capital Asset Pricing model
Ke = Rf +beta ( Rf – Rm)
Rf = risk free rate of return
Beta = stock relationship with a index
Rm = Market expectations of return ( Bloomberg base )
40
•If ROI approach is used to determine Ke then book value to be considered as weights.If market capitalization approach is used then market value to be considered as weights.
•All cost to be considered on a post tax basis.
•The market capitalization approach is superior to the ROI approach since the parameters are market determined and futuristic as compared to the ROI approach.
•The CAPM approach is a further refinement which also includes premium for risk
•In loss making companies minimum cash flow approach is used.
•Cost of equity could be benchmarked with return on guilts,market risk and portfolio risk ( Asset Beta )
41
WORKING CAPITAL MANAGEMENT
Objective: Optimise current asset deployment.
Advantages: Lower interest cost.
Inventory holding cost reduced.
Disadvantages: Interruption in production.
Stock out to customers.
42
ASSET STRUCTURE FOR VARIOUS INDUSTRIAL SEGMENTS
FA CA
Power Generation 80% 20%
Chemical process plants 50% 50%
Engineering 40% 60%
Service 20% 80%
Trading 10% 90%
43
WORKING CAPITAL
Current assets comprise of stocks of raw materials, work in progress, finished goods, and receivables.
Gross working capital = total current assets.
Net working capital = CA - CL
Objective is to optimse asset requirement and funding the same at minimal cost.
Working capital
requirementPermanent component
Variable component)
44
CONSTITUENTS OF CURRENT ASSETS
Raw material stock
Work in progress
Finished goods stock
Cash in hand / bank
Debtors / Receivables
45
OPERATING CYCLE TIME
Time required for rolling or rotation of current assets.
Date of receipt RM issued to Throughput time
of RM production Dept
Collection of Despatched to consumers Converted to FG
Receivables
46
FACTORS INFLUENCING WORKING CAPITAL REQUIREMENTS
•Nature of business
•Manufacturing process
•Competitive forces in raw material & finished goods segment.
•Infrastructural support.
•Through put time
•Seasonality in demand
•Shelf life of RM / Finished product
•Customer relationship management
47
CREDIT MANAGEMENT
•Terms of payment Cash against delivery
Consignee basis
Proforma invoice
Letter of credit
Advances
Suppliers / Buyers LOC
•Credit policy variables Credit standards
Credit period
Cash Discounts
48
•Credit evaluation Character
Capacity
Capital
Collateral
Macro conditions
•Control of accounts Days sales outstanding
receivables Ageing schedule (in days)
Collection matrix
Average collection period
49
RECEIVABLES MANAGEMENT
•Credit standards Collection cost
Average collection period
Bad debts
Level of incremental sale
•Credit terms
•Collection policies
•Factoring
50
CASH MANAGEMENT
Cash budgets : Quarterly / monthly / weekly
Operating cash inflow/ outflow items:
Cash inflow Cash outflow
Cash sales Accounts payable
Collection of receivables R.M purchase
Salary
factory expense
Administration/selling exp.
Taxes / Duties
51
WORKING CAPITAL FINANCING
•Cash accruals
•Trade credit
•Commercial bank borrowings
Cash credit limit
WCTL
Bill discounting
Letter of credit
Bank guarantee
•Public deposits
52
•Short term / medium term loans from FI’s Banks
•Debentures for working capital
•Commercial Paper.
•Euro Commercial Borrowings
•Inter Corporate deposits
•Trade credit notes ( commodity exchanges )
•Factors
53
Long Term Financing
Basis of evaluation
Availability
•Flexibility
•Cost
Availability : should be available at the point / time when required
Flexibility : certain instruments are user/ application specific
Cost : to be evaluated on a post tax basis
54
SOURCES OF TERM FINANCE
•Term loans from Financial institutions & Banks
•State level financial institutions
•Debentures: NCD
PCD
OFCD
•Fixed Deposits
•Equity share capital
•Equity share capital with differential rights
•Non voting shares
•Preference share capital
•Mutual Funds
55
•Retained earnings
•Exchangeables
•Venture Capital
•Deferred payment gurantees
•Leasing
•External commercial borrowings
•Depository receipts
•Floating interest rate Debt.
•Securitisation of future receivables
•Derivative linked bonds
56
FINANCIAL / INVESTMENT INSTITUTIONS
They are major source of long term debt funds for financing:
•Fixed Assets
•Margin money for working capital
Indian FI’s
IDBI / ICICI / IFCI / IIBI
Foreign Institutions
Sectoral Institutions
HDFC / IL&FS / HUDCO / IDFC
Universal Banks
ICICI Bank
57
Investment institutions
GIC & Subsidiaries
UTI
LIC
Investment Banks
•23 State level financial institutions (IDC’s)
•23 State level financial institutions (MSFC)
Scheduled Commercial Banks
58
Features: Interest rate is based upon the prime lending rate + project risk.
Basic interest rate linked to inflation rate
Linked to G-Sec rate or Sub - SBAR ( SBI PLR )
Security Hypothecation & mortgage
Collateral
Covenants
Moratorium period
Amortisation schedule
Door to Door tenure
59
GUIDE LINES FOR KEY RATIOS
DCSR > 1.8 TIMES
D/E 1:5:1
Promoters contribution : 20 - 25%
CR: > 1.33
ADDITIONAL FEATURES :
-Interest rate re-set clause
- Tapering of interest rate post project risk
60
Debentures:
•Approval from SEBI mandatory if public issue is proposed
•Debentures used to finance margin money not to exceed more than 20% of N.W.C
•Convertibility clause terms to be specified at issuance time.
•Credit rating mandatory
61
•Types of Debentures:
NCD
FCD
PCD
OCD
•Coupon rate depends on terms of issue.
Other features
•No TDS for interest paid upto Rs 2500 per annum
•Redemption premium
•Listing on stock exchanges
•Fully secured
•Call and put options
62
Advantages from Issuer’s point of view:
•Lower cost due to low risk and tax deductibility of interest payment.
•No / limited dilution of control
•Offer stable return to investors having fixed maturity
and subsequently redemption/ conversion to equity
•No increase in equity base during non conversion period
Fixed deposits
•Limit on quantum : 25% of networth
•Cost : 8-10 % depending on maturity period & risk
•unsecured
63
EQUITY SHARE CAPITAL
•Authorised , issued, subscribed and paid up
•Par value, issue price, book value, market value
•Residual claims on Income /Assets
•No upper limit
•Costliest sources of finance
•Entails permanent servicing by way of dividends without tax shield
•Voting rights/ Control in management/ Limited liability
•Under preview of SEBI and SEB guidelines
•Buy Back allowed
64
Equity investments in foreign cos allowed to resident indian shareholder in the event foregin co has 10% stake in indian co.
•For Listing on exchanges atleast 10% to be offered to the public by way of a prospectus
Issuance of Non-Voting & differential rights shares allowed
•Debentures on conversion becomes equity share capital.
•Listed / Unlisted shares
•Sweat Equity / Employee Stock Options
65
EVALUATION OF ESC
Company’s point of view
Advantages
Represents almost permanent capital
Does not involve any fixed obligation for servicing
Enhances credit worthiness of the company to secure additional debt.
Disadvantages
High cost of capital
Dividends paid on profit after tax further subjected to dividend distribution tax of 15%
High flotation cost
Dilution of control (Treasury issue)
66
Investors point of view
Advantages
Enjoy voting right in the company with limited liability.
Short term capital gains tax reduced to 10%
Long term Capital gains tax abolished. ( Exchange traded securities )
Indexation benefit available under 54E.
Disadvantages
Controlling power could be notional
Turn over tax at 15 basis points on sale of the security on an exchange
Have residual claim to income / assets
Vide fluctuations in stock price
Dividend’s subjected to distribution tax of 15%
67
Retained earnings
Made up of Accumulated depreciation and retained profits.
Represent the internal sources of finance available to the company.
Availability : Level of profitability / payout ratio
Cost : Identical to ESC.
Flexibility : High
68
Disadvantages
High opportunity cost
Limitation on amount
Bonus issue may capitalise reserves
Advantages
Reinvestment of profit may be convenient to many shareholders.
No dilution of control since Co. Relies on retained earnings
No flotation cost/ Losses on account of underpricing.
Proceeds could be used in a subsequent buyback.
.
69
Preference share capital
Fixed minimum dividend rate
No voting rights
Prior claim on income / assets
Redeemable at issuer’s & investor’s discretion
Features:
No dilution of control
Provision to skip dividend in absence of profits
70
CAPTAL BUDGETING
71
•Capital investment decision
Capital investments involve increase in the fixed assets of a company.
(Expansion / diversification / Green field / takeover / merger)
•Characteristics of investments
Capital outlay needs to be made up front returns come later
Certain amount of risk is involved
Capital investment tend to be indivisible. (difficult to phase out).
•Financial techniques
The purpose of financial techniques is to enable the making of investment acceptance / rejection decisions.
72
Non financial factors in project appraisal
Market
Technical
Infrastructure
Ecological
Economic
Influence of non - financial factors
Financial projections
Gestation period
Profitability
Life of project / Terminal value
Sensitivity analysis
73
NON FINANCIAL FACTORS DETERMINING
FINANCIAL VIABILITY OF PROJECTS
Market factors
Present and future size of the market
Present and future demand and supply situation
Achievable market share
Selling & distribution channels
Technical factors
Level of Technological obsolence
Plant location
Scales of operation
Raw material & utilities consumption norms
74
Ecological factors
Pollutant levels
Treatment of effluent
Environmental impact of the project
Economic factors
Social cost benefit analysis
Economic rate of protection
Domestic resource cost
Protection enjoyed by industry.
75
FINANCIAL TECHNIQUES IN CAPITAL BUDGETING
Return on investment
AVG ROI = PBIT
(over 10 yrs) Total Inv.
Advantages
Simple to calculate and easy to understand
Maximisation of shareholders wealth and maximising the market value of investments.
.Disadvantages
Time value of money not considered
It is a concept based on profit and not cash
No objective criterion for acceptance / Rejection decision.
76
Payback period
It is the time required to get back the original investment companies going through liquidity crisis /for small investments will use the pay back period method.
Disadvantages
Cash inflows / Outflows after payback Period are ignored.
Time value for money is ignored
77
Discounted cash flow (DCF)
Cash inflow and outflow for the entire life of the project is considered.
It considers time value for money as a result earnings in earlier years have higher value than earned in later years.
IRR Method
IRR is that rate of discount at which the net present value of cash flows equals net present value of cash outflows.
If IRR > COC Investment is support worthy.
NPV method
Using COC discount the netflows
If NPV is + VE investment is support worthy..
78
Comparison of elements
Elements Payback NPV IRR
Net investment. Comparable comparable Comparable
Subsequentinvestment
Possible to userough approx.
Exact timing Exact timing
Recovery ofterminal value
Not Possible Specificeconomic impact
Specificeconomic impact
Accountingprofit
Roughapproximation
Not relevant Not Relevant
Operating cashflow
Approximationof pattern
Not relevant Not relevant
79
Comparison of elements
Year by yearoperating cashflow pattern
Cannotaccomodate
Exact economicimpact
Exact Economicimpact
Economic Life Not considered Integral toanalysis
Integral toanalysis
Result Years to coverthe initialinvestment
Net Balance ofequivalent cashinflows andoutflows
Yield rate ofdiscount equatinginflows andoutflows.
80
CONCEPTS IN CAPITAL BUDGETING
•Life of project
Physical
Market
Techno efficient
•Incremental principle
Sunk / Allocated costs to be ignored
Only incremental cash flows to be considered
•Evaluation of post tax basis since COC is on a post tax basis
•Principle of separation of “Finance” from “Investment “ decision.
Financing cost (interest) to be ignored.
•Effect of tax shield on the company as a whole to be considered
81
PROJECT COST COMPONENTS
Land
Civil Construction
Plant & Machinery
Misc Fixed Assets
Erection and commissioning
Technical Know how fees
Preliminary & preoperative expenses
Contingencies
Total Capital Cost
Margin money for working capital
Total project cost
82
PROJECT CASH FLOWS
Cash outflows Capital expenditure
Margin money
Normal capital expenditure
Cash inflow Net cash accruals
Salvage value
Recovery of WC
83
NPV vs IRR conflict
• NPV is technically superior to IRR and is also able to handle selection of mutually exclusive projects.
• The decision rule for the NPV assumes that cash flows resulting during the life cycle of the project have an opportunity cost equal to the discount rate used.
• The decision rule for the IRR assumes that such resulting cash flows have an opportunity cost equal to IRR which generated them.
• NPV approach provides an absolute measure that fully represents the value from the project to a company.
• IRR by contrast provides a % figure from which the benefits in terms of wealth creation cannot be grasped.
84
Capital Budgeting Sensitivity Analysis
• Monte Carlo Simulation
• Break even analysis
• Decision tree analysis
• Expected value Criterion
• Alternate buisness plans
85
Share holder value creation
• Cash Dividends• Stock Dividends• Bonus Shares• Bonus Debentures-issued from free reserves• Equity Buy back / Secondary Listing• Stock Split• Synergic Investments • Synergic Acquisitions• Disinvest out of unrelated businesses• Shares of holding co. with fungibility
86
DIVIDEND STRUCTURING
Appropriation of PAT towards Dividend pay out and Reserves
Payout ratio = Dividend paid / PAT
Retention ratio = PAT - Dividend paid / PAT
Dividend rate (%) could be high but payout could be low.
Dividend rate will be depended upon the PAT, Payout ratio and Equity base.
87
Dividend Structuring
100% retention scenario
For some shareholders dividend acts as a regular income source EX: investor’s for whom it is a regular source of income, mutual funds, investment companies.
Declaration of dividend is perceived as an indication that the companies operations are profitable.
100% payout scenario
Repeated raising of capital increases floatation cost
Companies requirement for expansion / margin money / new investment.
Tax inefficient due to 15% distribution tax.
88
Factors influencing dividend policy
•If the appetite for funds is high due to increase in level of exsisting operation or due to major capital investment plan then a high retention policy will be adopted.
•A closely held company having major capital investment plans will follow a low pay out policy so that internal accruals could act as a major source of finance in the future thereby reducing dependence on infusion of fresh equity.
•Tax implications
Company has to pay 12.5% distribution tax.Recipient of dividend tax exempted in the shareholders hands..
Section 80-M exemption at 100%
89
•Restriction in loan agreement / government regulations / FI’s on on payment of dividend during the currency of the loan.
•Legal requirement under Companies act.
•Liquidity position : Higher PAT does not necessarily mean healthy liquidity. A strained liquidity position would force a policy of low payout.
•Stability in the rate of dividend : companies usually follow a policy of gradually rising or stable dividend policy and not directly link it with PAT.
•Generally the Indian corporate sector follows a payout policy of 30% . The retention ratio keeps increasing so as to counter inflation, floatation cost, help in Equity buyback etc.
90
BONUS SHARES
Bonus share are issued to existing share holders as a result of capitalization of reserves.
In the wake of a bonus issue
The shareholders proportional ownership remains unchanged
The book value, market price, E.P.S decreases.
Fallout of a bonus issue
•Normally the Ex-bonus price comes down by the proportion of bonus given with a mark up of approximately 30 - 35%
•More active trading in stock exchanges.
•The nominal rate of dividend tends to decline this may dispel the impression of profiteering.
•Shareholders regard a bonus issue as a firm indication that the prospects for the company are good.
•Capital gains tax exemptions with indexation available for bonus issue
91
GUIDELINES FOR ISSUE OF BONUS SHARES
Issuer : Security exchange board of India
Bonus issue should be made from capitalisation of free reserves built out of genuine profits and share premium.Reserves created by revaluation of assets, statutory reserves etc. are not allowed for capitalisation
Bonus issue greater than 1:1 allowed
Residual reserve test: residual reserves after the proposed capitalisation should be at least 40% of the increased capital For computation all contingent liabilities, statutory reserves and revaluation reserves to be excluded.
Yield test: 30% of the average P.B.T for the last 3 years should give a return of at least 10% on the enhanced capital.
Bonus in lieu of dividend is not permitted
92
If R = Reserves before bonus issue
S = Share capital before bonus issue
B = Bonus Quantum
PRT = Average PBT for last 3 years
RPT = .4 (S + B) > (R - B)
YIELD TEST = .3 (PBT) > (.1) (S+B)
Bonus issue also to be given to debenture holders if there is an impending conversion.