Dividend policy

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.

Lost Pigeon Avionics CFO has stated that the firm will pay dividends only after all acceptable capital budgeting projects have been financed using retained earnings to the extent possible. Which concept did the CFO most likely base her decision on?

Dividend irrelevance theory

The clientele effect

The signaling hypothesis

The residual dividend model

Consider the case of Blue Water Producers Inc., and answer the question that follows:

Blue Water 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?

It maximizes the firms earnings per share.

It maximizes the firms total assets.

It maximizes the firms return on equity.

It maximizes the firms stock price.

Which of the following statements is true?

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

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

As a result, the U.S. tax code encourages many individual investors to prefer to receive .

Some researchers and analysts have noticed a trend in which firms that increase their dividends see an increase in their stock price. The theory of explains this phenomenon.

In some cases, analysts notice that groups of similar investors tend to flock to stocks that have dividend policies consistent with their needs. This circumstance is an illustration of:

the information content effect.

the clientele effect.