1. Dividend policy Vick Shipping paid a dividend of $1.50 last year, and its div
ID: 2646942 • Letter: 1
Question
1. Dividend policy Vick Shipping paid a dividend of $1.50 last year, and its dividend has increased steadily by about 4% a year. Vick Just announced that Its dividend will increase to $2.10 thI5 year, and its stock price rose from $26 to $28 Immediately after the announcement. Which of the following best explains why the price increased as it did? M-M dividend irrelevance The signaling hypothesis The residual dividend model The clientele effect Which class of investors is more likely to be pleased by Vick?s dividend announcement? Investors with low tax rates who depend on current dividend income for living expenses Investors with high tax rates who don?t depend on current dividend income for living expensesExplanation / Answer
The Clientele Effect (which is Option D)
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Details Provided Below:
As per the clientele effect, the stock price frequently adjust as a result of change in stock holdings of the investors. This change in stock holding arises from changes in company's policies (such as increase /decrease in payment of dividend per share).
Here, the company increased its dividend from 4% to 40% [(2.10 - 1.50)/1.50*100] as a result of which demand for the stock must have increased resulting in an increase in the stock price from $26 to $28 which indicates the clientele effect.
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Part b)
Investors with high tax rates who don't depend on current dividend income for living expenses (which is Option B)
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Details Provided Below:
Capital gain on stock is taxed at a rate lower than the tax on dividends. Therefore, payment of dividend will result in more taxes for investors who prefer to receive immediate income (in the form of dividends) for their living expenses as against investors who may be subject to high tax rates but don't depend on current dividend income for living expenses (as they can enjoy lower tax rates on capital gains realized from the appreciation in stock price).
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