A firms value depends on its expected free cash flow and its cost of capital. Distributions made in the form of dividends or stock repurchases impact the firms value and the investors in different ways.

Consider the scenario, and answer the questions that follow:

InOutOil Company is an oil drilling company. The company paid a dividend of $1.75 last year, and in the past its dividend has increased steadily by 4% per year. InOutOil just announced that its dividend will increase to $2.50 this year, and its stock price rose from $30 to $33 immediately after the announcement.

Which of the following theories best explains why the stock price increased as it did?

Dividend irrelevance theory

The signaling hypothesis

The clientele effect

Modigliani and Miller argued that each shareholder can construct his or her own dividend policy. This statement is:

True

False

Modigliani and Miller also pointed out that many institutional investors do not pay taxes and can buy and sell stocks with very low transaction costs. For these investors, dividend policy is ________ relevant than it is for an individual investor. (more/less)