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

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.

Consider the scenario, and answer the questions that follow:

1.) 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?

A) The signaling hypothesis

B) The clientele effect

C) dividend irrelevance theory

2.) Which of these statements is true?

A) Taxes on dividends are paid when the stock is sold.

B) Taxes on dividends are paid in the year that they are received.

3.) Consequently, the tax code encourages many individual investors to prefer ______?   .

4.) 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.

5.) 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:

A) The clientele effect

B) The information content effect

Explanation / Answer

1. CLientele effect

2. Taxes on dividends are paid in the year that they are received.

3. capital gains

4. Information content effect

5. Clientele effect

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