Question

Explain the financial objectives of cash dividends, stock dividends and bonus issue. In an efficient market what would be the relationship between the pre and post transaction share price.

Answer 1

Cash dividends are cash paid out directly to shareholders. Objective of cash dividends:

1. Some shareholders prefer it as it provides them with a regular income.
2. It would lead to an increased demand for the company’s stock. This would in turn increase the price of the stock.

Stock dividends is payment of additional units of shares instead of cash. Objective of stock dividend:

1. Stock dividends are not paid from the firm income. The firm can retain cash and still pay dividend.
2. Stock dividends are not taxed until the shares are sold.
3. It increases the number of shares outstanding
4. It reduces the price of the share in the market and thereby making the stock more affordable and attractive to investors.

Bonus issue is an offer of additional shares to shareholders. Objective of bonus issues:

1. There is no inflow or outflow of cash flows for bonus issues. So, the company can conserve its cash.
2. It increases the company’s share capital.
3. Increases the credit worthiness and market image of the company.
4. More availability of capital for the company.

The share price of the target company tends to increase pre and post the acquisition. But the share price of the acquiring company tends to fall after the acquisition if the market feels the takeover price is too high and as a result of the additional debt burden absorbed from the takeover. But the share price of the acquiring company may increase if the market views it has a good deal which would increase the value of the firm in the future.

I hope that was helpful :)