A firm\'s value depends on its expected free cash flow and its cost of capital.

Question

A firm'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. Some analysts have argued that a firm's value should solely be determined by its basic earning power and the business risk of the firm. Which of these concepts would support these analysts' argurment? O The clientele effect O The free cash flow hypothesis O Dividend irrelevance theory O The signaling hypothesis Consider the case of Green Mountain Producers Inc., and answer the question that follows: Green Mountain Producers Inc. is an oil drilling company. The company paid a dividend of $2.20 last year, and, in th past, its dividend has increased steadily by about 4% a year. Green Mountain just announced that its dividend will increase to $2.90 this year, and its share price rose from $33 per share to $35 per share immediately after the announcement. which of the following best explains why Green Mountain's stock price increased as it did? O The signaling hypothesis O Dividend irrelevance theory O The clientele effect Which of the following statements is true? O Taxes on dividend income s are paid when the stock is sold. O Taxes on dividend income are paid in the year that they are received a result, the U.S. tax code encourages many individual investors to prefer to receive

Explanation / Answer

Ans 1) Dividend irrelevance theory suggests that there is no effect of dividend on firm's value, it will be derived from firm's earning power and business risk.

Ans 2) Increase in stock price due to increase in dividend is explain by the signalling hypothesis.

Ans 3) Taxes on dividend income are paid in the year that they are received.

Ans 4) US tax code encourages many individual investors to prefer to recieve capital gains.

Ans 5) Investors with low tax rate will be pleased by increase in dividend income.

Ans 6) A firms past dividend policy determines its current clientele investors.

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