The Effect of a Bonus Issue on the Market Value

question 70

Multiple Choice

The effect of a bonus issue on the market value of an entity's equity is:

• A) The number of shares is increased, meaning that each shareholder benefits from the conversion of retained earnings into additional shares. Each shareholder benefits proportionately equally, however, so their relative positions remain the same.
• B) The total equity of the entity remains the same, apart from the reclassification of reserves used to make the bonus issue. Each shareholder benefits from the ability to sell off the additional shares provided, so the market value of the entity remains the same.
• C) The market price is observed to drop as a result of the increased supply of shares for sale because shareholders often respond to a bonus issue by selling off the 'windfall' shares.
• D) Theoretically it should have no effect, but empirical evidence suggests that a bonus issue is used to signal an increase in dividends, so the total market value of the entity does sometimes increase.

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Definitions:

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