3. Dividend policy Afirm\'s value depends on its expected free cash flow and its
ID: 2617734 • Letter: 3
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3. Dividend policy Afirm's 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 firm's value and the investors in different ways Savvy Camel Trucking Company's CFO has stated that the firm will pay dividends only if acceptable capital budgeting opportunities do not exist. Which concept did the CFO most likely base her decision on? O The free cash flow hypothesis O Dividend irrelevance theory O The signaling hypothesis O The cientele effect Suppose a firm generates a lot of cash but has limited investment opportunities. Is this stock more likely to be a utility stock or a technology stock? In addition, is the stock more likely to provide a high or low dividend yield? O A utility stock that has a high dividend yield O A technology stock that has a low dividend yield O A technology stock that has a high dividend yield O A utility stock that has a low dividend yield Modigliani and Miller argued that rach shareholder can construct his or her own dividend policy. This statement is: O False O True 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. 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 Robbem's dividend announcement? with high tax rates who don't depend on current dividend income for living expenses O Investors with low tax rates who depend on current dividend income for living expenses A firm's dividend policy determines its current clientele of investors.Explanation / Answer
The CFO is not paying attention to paying dividends when there is capital budgeting opportunity i.e. dividend is irrelevant when other value addition projects can be done using the cash instead of paying dividend.
Thus the CFO is basing its decision mainly on dividend irrelevance theory which states that investors do not pay attention to dividend history or the dividend is irrelevant in calculating the value of a company.
Hence the second option is correct.
Utility stock may generate a lot of free cash flows but there may not be enough investment opportunities. Hence they will pay most of the generated cash as dividends and thus dividend Yield will be higher.
Thus the first option is correct.
MM Theory suggests that each shareholder can create their own dividend policy by buying and selling shares in the market.
Hence the statement is True.
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