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Equity Markets in India pp 65–91Cite as

Rates of Return—Investors’ Perspective

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Part of the book series: India Studies in Business and Economics ((ISBE))

Abstract

An investor who purchases the equity shares of a company has two sources of income from such an investment. The first is dividends—the sharing of the after-tax profits of a company with its owners—and the second is capital appreciation. Typically, for high-growth companies (like many such companies in the sample comprising the top 500 companies listed at the National Stock Exchange (NSE)), dividend income is not a favoured option.

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Author information

Authors and Affiliations

  1. Department of Management Studies, Indian Institute of Technology Delhi, New Delhi, India

    Shveta Singh, P. K. Jain & Surendra Singh Yadav

Authors
  1. Shveta Singh
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  2. P. K. Jain
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  3. Surendra Singh Yadav
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Corresponding author

Correspondence to Shveta Singh .

Annexure 4.1

Annexure 4.1

Disclaimer: These examples have been adapted from the Website ‘ Accounting Simplified.com ’ for illustrative purposes to enhance the understanding of the readers.

Example of Bonus Share Adjustment

ABC Ltd., which has a year-end of 31 December 2012, issued 1 for 4 bonus shares on 30 June 2012.

  • Following information relates to ABC Ltd.:

  • Ordinary Shares as on 1 January 2011= 40,00,000 (40 lakhs)

  • Earnings attributable to ordinary shareholders:

  • INR 50,00,000 2011

  • INR 50,00,000 2012

Calculation of Earnings Per Share for 2011 and 2012 for presentation in financial statements for the year ended 31 December 2012 would be as follows:

Step 1:

Calculate the number of bonus shares

 
 

Number of shares eligible for bonus shares

40,00,000

 

Number of bonus shares (40,00,000 × 1/4)

10,00,000

Step 2:

Calculate weighted average Shares

 
 

2011 Shares at the start of the year

40,00,000

 

Add: Bonus shares (Step 1)

10,00,000

 

Weighted average shares

50,00,000

 

2012 Shares at the start of the year

40,00,000

 

Add: Bonus shares (Step 1)

10,00,000

 

Weighted average shares

50,00,000

Note that even though bonus shares were issued half way through 2012, they are included in the calculation of weighted average shares without time apportionment for both 2012 and 2011 (i.e. as if the bonus shares had been issued before the year 2011).

Step 3:

Calculate earnings per share

 
 

2011 Earnings attributable to ordinary share holders

INR 50,00,000

 

Weighted Average Shares (Step 2)

50,00,000

 

Earnings per share (INR 50,00,000/50,00,000)

INR 1

 

2012 Earnings attributable to ordinary share holders

INR 50,00,000

 

Weighted Average Shares (Step 2)

50,00,000

 

Earnings per share (INR 50,00,000/50,00,000)

INR 1

Note that despite the bonus issue, there is no change in the earnings per share for the two years as there is no change in earnings. The effect of bonus issue is eliminated by incorporating the bonus shares adjustment in the calculation of weighted average shares for both years.

The EPS calculated as above illustrates the fact that the performance of ABC Ltd. has remained stable over the past two years. If no adjustment for bonus shares had been made, EPS for 2012 would be lower than 2011 despite the fact that there is neither a change in the earnings nor in the resources to earn a return to shareholders. This would have presented an unfair comparison of the performance of ABC Ltd.

Calculation of weighted average shares for subsequent periods will also incorporate bonus shares in similar manner (i.e. added in full without time apportionment).

Example for Rights Issue Adjustment

ABC Ltd. issued 1 for 4 rights shares on 31 March 2013 at an exercise price of INR 1. Market value of its shares immediately prior to the rights issue was INR 1.5 per share. ABC Ltd. had 10 lakh shares before the issuance of rights shares. All rights were exercised by shareholders on 31 March 2012.

Formula

$${\text{Theoretical}}\,{\text{Ex}} - {\text{Rights}}\,{\text{Price = }}\frac{{{\text{Market}}\,{\text{Value}}\,{\text{of}}\,{\text{shares}}\,{\text{prior}}\,{\text{to}}\,{\text{rights}}\,{\text{issue}} + {\text{Cash}}\,{\text{raised}}\,{\text{from}}\,{\text{rights}}\,{\text{issue}}}}{{{\text{Number}}\,{\text{of}}\,{\text{shares}}\,{\text{after}}\,{\text{rights}}\,{\text{issue}}}}$$

Theoretical Ex-Rights Price may be calculated as follows:

Step 1: Calculate market value of ABC Ltd. prior to the rights issue

Market Value before rights issue

(INR 1.5 × 10 lakh shares)

INR 15,00,000

Step 2: Calculate cash proceeds raised from the rights issue

Cash raised from rights issue

(INR 1 × 2,50,000*)

INR 2,50,000

*(10 lakh/4 = 2,50,000 rights shares)

  

Step 3: Calculate number of shares after the rights issue

Number of Shares

(10,00,000 + 2,50,000 [step 2])

12,50,000

Step 4: Calculate Theoretical Ex-Rights Price

\({\text{Theoretical}}\;{\text{Ex}} - {\text{Rights Price}} = \frac{{{\text{INR}}\,15,00,000\,(Step\,1) + {\text{INR}}\,250,000 (Step\,2)}}{12,50,000 (Step\,3)} = {\text{INR}}\,1.4\,{\text{per}}\,{\text{share}}\)

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Singh, S., Jain, P.K., Yadav, S.S. (2016). Rates of Return—Investors’ Perspective. In: Equity Markets in India. India Studies in Business and Economics. Springer, Singapore. https://doi.org/10.1007/978-981-10-0868-9_4

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