Transcribed Text for Educational Website:12. Which of the following statements is CORRECT?a. Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings that a firm pays out in dividends has no effect on its cost of capital, but it does affect its stock price.b. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument.c. Other things held constant, the higher a firm's target dividend payout ratio, the higher its expected growth rate should be.d. The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, an increase in the tax rate on dividends relative to that on capital gains would logically lead to a decrease in dividend payout ratios.e. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high dividend payout ratio.---Note: The image only contains text and no graphs or diagrams.

a) This statement is untrue. Modigliani and Miller suggested that a dividend policy is irrelevant and proposed that the dividend policy of a company has no effect on either the stock price of a company or the company's capital structure. b) This statement is untrue. Modigliani and Miller's dividend irrelevance theory suggests that a company’s dividend payments don't add value to a company’s stock price. c) This statement is untrue. A target payout ratio that is too high could send a negative signal to the market, since it may indicate the company isn't retaining enough capital to grow efficiently. d) This statement is true Dividends are usually taxed more heavily than capital gains. So, a stockholder will prefer to receive capital gains over dividends if the taxes are higher. e) This statement is untrue. If such a firm has to maximize its stock price, its retention ratio should be high. The correct answer is option d) An increase in tax rates of dividends will lead to a decrease in dividend payout ratios.

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Modig theory says percentage earnings that a firm pays in dividends has no effect on its cost of capital, but it does affect its stock price. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument. Other things held constant, the higher a firm's target dividend payout ratio, the higher its expected growth rate should be. The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, an increase in the tax rate on dividends relative to that on capital gains would logically lead to a decrease in dividend payout ratios. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high dividend payout ratio.

Modig theory says percentage earnings that a firm pays in dividends has no effect on its cost of capital, but it does affect its stock price. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument. Other things held constant, the higher a firm's target dividend payout ratio, the higher its expected growth rate should be. The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, an increase in the tax rate on dividends relative to that on capital gains would logically lead to a decrease in dividend payout ratios. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high dividend payout ratio.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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14. Which of the following statements is CORRECT? a. Other things held constant, the higher a firm's target dividend payout ratio, the higher its expected growth rate should be. b. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high dividend payout ratio. c. Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings that a firm pays out in dividends has no effect on its cost of capital, but it does affect its stock price. d. The federal government sometimes taxes dividends and capital gains at different rates. Other things held constant, an increase in the tax rate on dividends relative to that on capital gains would logically lead to a decrease in dividend payout ratios. e. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% dividend payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some…
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