Question

You are the Chief Financial Officer of Hilton Ltd, a large manufacturing company operating within the Asian-pacific region. The CEO, Mr Ray Ellis, has just returned from a shareholders engagement event to promote the company’s upcoming right issue of shares. He was confronted with some questions relating to issue of shares and whether there were any pros and cons to issuing shares via rights, bonus or by private placement. Issues related to the company’s earnings per share (EPS) also came up during the event. Mr Ellis was unimpressed with both the questions and his inability to respond in a comprehensive manner. He promised the shareholders that he would email them with clear responses to the issues raised, after he consulted with his Chief Financial Officer.
In consulting you, Mr Ellis would like to know your thoughts on the following:
 What is the difference between rights issue and bonus issue of shares?
 What are the advantages and disadvantages of both methods of issuing shares?
 Should Hilton Ltd consider a private placement and is there any benefit to having a private placement instead of a rights issue?
 What effects does a bonus issue of shares made in the middle of a financial year have on the EPS calculations of a company?

Required
Write a short memorandum format report to the CEO of Hilton Ltd to answer his questions. Your report should cover all four questions raised by Mr Ellis. Each question should be answered under a sub-heading within the report with appropriately cited references.

Answer 1

CHIEF EXECUTIVE MEMO

To: Mr Ray Ellis, CEO, Hilton Ltd

From: XYZ, CFO

Date: 23/09/2018

Re: Answer to the questions

Enclosed please find the response to the questions relating to issue of shares and whether there were any pros and cons to issuing shares via rights, bonus or by private placement. Sub-Heading are used for all those questions and are as follows.

1. Rights Issue vs Bonus Issue

Rights issue are the shares issued to the existing shareholders i.e. they have a priority over issue of new shares. These new shares before being offered to the market are issued to the existing shareholders at discounted price for a specified period than the price to be offered in the general market. Right shares are mandatory for the companies. These shares can be fully or partly paid.

Bonus issue are the shares issued by a company to the existing shareholders without any cost i.e. free of cost. These are in the proportion of their holdings. Companies may provide bonus shares to the shareholders instead of Dividends. The aim is to make Market price attractive and to raise the subscription of shares. These are created out of Reserves or retained earnings. These are always fully paid up.

2. Advantages and disadvantages of both methods

Rights Issue

Advantages –

* It helps to avoid underwriting fees.

* Shares are offered at discounted price.

* Increased Value of firm

* Existing shareholders have a priority over the others.

Disadvantages –

* Market may view this move as the company is struggling one.

* It lowers company’s EPS.

* Diluted Shares

Bonus Issue

Advantages –

* Issued free of cost

* Equity stakes are not diluted

* Instead of giving cash dividends bonus shares are given to put cash to projects.

* Creditors are secured

Disadvantages –

* Less liquidity to shareholders.

* Drop in share prices

* Drop in EPS

3. Private Placement

A private placement is when a business sells its shares directly to investors without issuing them in the open market or stock exchange. These investors are usually insurance companies or high net worth individuals.

Advantages:

* It allows one to choose their own investors. It increases the probability of getting investment from people/institutions that have similar objective.

* Investors through private placement are more resistant to short term risks and can help maintain stability of shares in market by not selling them due to short term fluctuations.

* Rights issue may not be subscribed by the existing shareholders and the company may have to incur cost to sell remaining shares in open market.

So, the company may consider private placement.

4. Effect of Bonus Issues on EPS

Bonus shares leads to increase in number of shares of the firm

EPS = Net Income/Number of Shares

As number of shares increase, the EPS would decrease for the same Net Income.

Please let me know if you want me to take on any aspect of this document.

References

* Brahmachary, A. (2018, April 05). Rights Issue vs Bonus Issue: The Difference You Need to Know. Retrieved from https://www.financeorigin.com/rights-issue-vs-bonus-issue/

* Advantages and Disadvantages of Bonus Shares. (2018, August 31). Retrieved from https://efinancemanagement.com/sources-of-finance/advantages-and-disadvantages-of-bonus-shares

* Bonus Issues and Earnings per Share under IAS 33 |. (2015, September 05). Retrieved from https://www.charterededucation.com/ifrs/bonus-issues-and-earnings-per-share-under-ias-33/

* Disadvantages of Rights Issue to Shareholders - Rights Issue Pros and Cons | Motilal Oswal. (n.d.). Retrieved from https://www.motilaloswal.com/article_new.aspx/1798/8-things-you-must-be-aware-of-when-subscribing-to-a-rights-issue

* M. (2018, March 22). Advantages and disadvantages of raising finance through private placements. Retrieved from https://www.nibusinessinfo.co.uk/content/advantages-and-disadvantages-raising-finance-through-private-placements

* Gains from bonus shares. (n.d.). Retrieved from https://www.google.co.in/amp/s/www.financialexpress.com/industry/banking-finance/gains-from-bonus-shares/3700/lite/