Question

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 scenario, and answer the questions that follow:

Suppose a firm generates a lot of cash but has limited investment opportunities. Is this stock more likely to be a utility stock or a technology stock? In addition, is the stock more likely to have a high or low dividend yield?

A technology stock that has a high dividend yield

A utility stock that has a low dividend yield

A technology stock that has a low dividend yield

A utility stock that has a high dividend yield

Which of these statements is true?

Taxes on dividends are paid in the year that they are received.

Taxes on dividends are paid when the stock is sold.

Consequently, the tax code encourages many individual investors to prefer.

Capital Gains

Dividends

Another firm, called Purity Power & Water, an established public utility company, has been paying dividends for the past 20 years. This year Purity also announced that it will increase its dividends by 10%. Which class of investors is more likely to be pleased by Purity’s dividend announcement?

Investors with high tax rates who don’t depend on current dividend income for living expenses

Investors with low tax rates who depend on current dividend income for living expenses

A firm’s ______ dividend policy determines its current clientele of investors.

Future

Past

Answer 1

1. Technology stock with a low dividend yield. Similar to this would be the case of apple, it also has a lot of cash and very less investment opportunity and the dividend is less because they need to keep excess cash for development of technology.

2. Taxes are paid on the dividend in the year they are received.

3. Individual prefer dividends as they do not have to pay taxes on them. The company pays the tax on dividends.

4. Investors with low tax rates who depend on current dividend income for living expenses will be pleased if the company increases dividends

5. Past Dividend policy determines the current clientele of investors.