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 case of Purple Sage Producers Inc., and answer the question that follows: Purple Sage Producers Inc. is an oil drilling company and has some free cash flow that is not expected to be used to finance future growth or potential investment projects. The company plans to distribute its free cash flow to its shareholders but is still deciding whether the distribution should take the form of a stock repurchase or the payment of a cash dividend. Which of the following is a characteristic of a firm’s optimal dividend policy? It maximizes the firm’s total assets. It maximizes the firm’s intrinsic value. It maximizes the firm’s earnings per share. It maximizes the firm’s return on equity. Modigliani and Miller argued that each shareholder can construct his or her own dividend policy. This statement is: True False 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 Less/More relevant than it is for an individual investor. 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 Clientele effect/ information content explains this phenomenon. 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: The clientele effect The information content effect

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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4. Dividend policy

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 case of Purple Sage Producers Inc., and answer the question that follows:

Purple Sage Producers Inc. is an oil drilling company and has some free cash flow that is not expected to be used to finance future growth or potential investment projects. The company plans to distribute its free cash flow to its shareholders but is still deciding whether the distribution should take the form of a stock repurchase or the payment of a cash dividend.

Which of the following is a characteristic of a firm’s optimal dividend policy?

It maximizes the firm’s total assets.

It maximizes the firm’s intrinsic value.

It maximizes the firm’s earnings per share.

It maximizes the firm’s return on equity.

Modigliani and Miller argued that each shareholder can construct his or her own dividend policy. This statement is:

True

False

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 Less/More relevant than it is for an individual investor.

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 Clientele effect/ information content explains this phenomenon.

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:

The clientele effect

The information content effect

Expert Solution

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(1)

The optimal distribution policy aims towards maximizing the organisation's value that is represented by firm's intrinsic value.

Therefore option (b) is correct.

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