Lecture on Equity Finance and Raising Finance from Shareholders

Introduction

• Lecture from Open Tuition, recommends downloading free lecture notes for full benefit.
• Focus on chapter 11 about raising finance from shareholders through equity finance.
• Discussion on issuing new shares, rights issue, and their arithmetic.

Key Topics Covered

Bonus Issue

• Known as script issue; familiar from F3 exams or equivalent studies.
• Not a source of finance: Free shares issued to existing shareholders.
• Shares are issued fairly (e.g., one-for-one, one-for-two).
• Purpose:
  • Reduce high share prices on stock exchange (psychological barrier).
  • Improve marketability of shares by increasing buying and selling activities.
  • Example: Microsoft high share price.
• Mechanism:
  • Current shares are doubled, reducing individual share price (e.g., from $50 to $25).

Stock Split

• Similar to bonus issue, not a source of finance.
• Shares are replaced with a greater number of new shares of lesser value.
• Purpose:
  • Also aims to reduce share price.
  • Mechanism involves cancelling existing shares and issuing new ones.

Script Dividend

• A source of finance.
• Shareholders offered shares instead of cash dividends.
• Provides choice between cash or equivalent value in shares.
• Benefits:
  • Companies retain cash, aiding in expansion and investment.
  • Shareholders can choose based on their financial needs.

Internally Generated Finance

• Most important source: Retained earnings.
• Profits can either be paid fully as dividends or partially retained for reinvestment.
• Reasons for retention:
  • Fund new investments or expansions without external financing.
  • Ensures business growth with available profits.
• Limitations:
  • Only limited to the profit available for use.

Dividend Policy

Dividend Relevance Theory

• Dividends seen as irrelevant in the long term as retained earnings boost future dividends.

Clientele Effect

• Investors choose companies based on dividend policies.
• Changing policies can upset shareholders and alter investment appeal.

Signaling Effect

• Changes in dividend policy could signal company health.
• Lower dividends might be interpreted negatively, even if for strategic growth.
• Companies tend to maintain consistent dividend policies to avoid shareholder unrest.

Conclusion

• Understanding of equity finance strategies and dividend implications is crucial.
• Next chapter will cover debt finance.