Which of the following statements is CORRECT? A. Suppose a firm that has been ea

Question

Which of the following statements is CORRECT? A. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% 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. B. Other things held constant, the higher a firm's target payout ratio, the higher its expected growth rate should be. 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. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high payout ratio. Which of the following statements is CORRECT? A. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% 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. B. Other things held constant, the higher a firm's target payout ratio, the higher its expected growth rate should be. 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. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high payout ratio. A. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% 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. B. Other things held constant, the higher a firm's target payout ratio, the higher its expected growth rate should be. 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. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high payout ratio. A. Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% 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. B. Other things held constant, the higher a firm's target payout ratio, the higher its expected growth rate should be. 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. If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a high payout ratio.

Explanation / Answer

A. Incorrect: Miller and Modigliani state that the capital structure is irrelevant to the value of the firm. Therfore the amount of dividend the company gives out is irrelevant. Hence Miller and Modigliani would disagree.

B. Incorrect: HIgher payout ratio means the company is retaining less money (which is also equal to money less cashed out by investors) Hence since investors have more money invested the expected growth should be more.

C. Incorrect: Miller and Modigliani say the value of the firm is not affected. Since the value of the firm is the stock price, this statement is incorrect.

D. Correct: If capital gains on dividends are higher in price the investors would want the payout ratio to be less since they would have to pay less tax on capital gains.

E. Incorrect: Since it is stated that investors prefer firms which have higher retained earnings that is lower payout ratio, the value of the share would be maximized when the payout ratio is high and not low

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