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 case of Red Dirt Producers Inc., and answer the question that follows:

Red Dirt Producers Inc. is an oil drilling company and has some free cash flow that is not expected to be used to finance future growth or potential investment projects. The company plans to distribute its free cash flow to its shareholders but is still deciding whether the distribution should take the form of a stock repurchase or the payment of a cash dividend.

Which of the following is a characteristic of a firms optimal dividend policy?

a) It maximizes the firms intrinsic value.

b) It maximizes the firms return on equity.

c) It maximizes the firms total assets.

d) It maximizes the firms earnings per share.

Which of the following statements is true?

a)Taxes on dividend income are paid in the year that they are received.

b) Taxes on dividend income s are paid when the stock is sold.

As a result, the U.S. tax code encourages many individual investors to prefer to receive....(dividends or capital gains).

Another firm, called Robbem Power & Water, an established public utility company, has been paying dividends for the past 20 years. This year Robbem also announced that it will increase its dividends by 10%. Which class of investors is more likely to be pleased by Robbems dividend announcement?

a) Investors with low tax rates who depend on current dividend income for living expenses

b) Investors with high tax rates who dont depend on current dividend income for living expenses

A firms (past or future) dividend policy determines its current clientele of investors.