Which of the following statements is correct? a. If a firm follows the residual

Question

Which of the following statements is correct? a. If a firm follows the residual dividend model, then a sudden increase in the number of profitable projects would be likely to lead to a reduction of the firm's dividend payout ratio b. The clientele effect explains why so many firms change their dividend policies so often c. One advantage of adopting the residual dividend model is that this policy makes it easier for a corporation to attract a specific and well-identified dividend clientele d. New-stock dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don't change the firm's total amount of book equity e. Investors who receive stock dividends must pay taxes on the value of the new shares in the year the stock dividends are received

Explanation / Answer

The following statements are correct with reasons as provided below:

a. This is correct. As the number of profitable projects increase, the management will have good justification to allocate more funds towards capital expenditures & thus the part of net income left for dividends may decrease thus leading to a redution in the firm's dividend payout ratio.

b. This is wrong. The clientele effect describes the behaviour of investors towards company policies & not vice versa.

c. This is correct. The residual model will attract high growth seeking investors as this model prefers reinvesting for growth over dividends.

d. This is wrong as the Dividend reinvestment plans do increase the firm's total amount of book equity.

e. This is wrong. Tax on Stock dividends is only to be paid until they are sold by the investor.

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