The Effect of a Bonus Issue on the Market Value

question 41

Multiple Choice

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

• A) The number of shares are 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) Because shareholders often respond to a bonus issue by selling off the 'windfall' shares, the market price is observed to often drop as a result of the increased supply of shares for sale.
• 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.
• E) None of the given answers.

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Definitions:

Lost Profits

The potential earnings that were not realized due to unforeseen circumstances, disruptions in business, or decisions that led to lost sales opportunities.

Planning Horizon

The future time period for which plans, strategies, and decisions are made, varying in length depending on the goals and nature of the planning.

Forecasting Errors

Discrepancies between predicted and actual demand, often leading to inventory mismanagement.

Safety Capacity

The extra capacity created within a system to accommodate unexpected demand or to compensate for potential system failures.