If the tax differential theory of dividend policy is correct, then The stock pri
ID: 2732916 • Letter: I
Question
If the tax differential theory of dividend policy is correct, then
The stock price will decrease as the retained earnings increase (dividends decrease).
The stock price will increase as the retained earnings increase (dividends decrease).
Firms should follow a high payout policy.
The stock price will either rise or fall by a change in dividend policy.
Dividend policy is irrelevant.
1.The stock price will decrease as the retained earnings increase (dividends decrease).
2.The stock price will increase as the retained earnings increase (dividends decrease).
3.Firms should follow a high payout policy.
4.The stock price will either rise or fall by a change in dividend policy.
5.Dividend policy is irrelevant.
Explanation / Answer
The correct option should be 2. The stock price will increase as the retained earnings increase (dividends decrease) Option 4: The stock price will either rise or fall by a change in dividend policy is also correct.
If the tax differential theory is correct, investors prefer a low payout and high capital appreciation as the tax on dividends is higher than the tax on capital appreciation. Also, by increasing the retention ratio, companies have more cash available for capital expenditures and growth, thereby aiding the cause of maximising shareholder value and increasing stock price.
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