Question

1. Imagine two companies that are essentially identical (the same industry, very similar products, similar size, sales, and profits). One of them (company X) has decided to give away ALL of its profits as dividends every year. The second company (company Y) has decided to keep all of the profits to expand its business and pay zero dividend. Shortly thereafter, both companies have announced the plans to "go public" through the Initial Public Offering (IPO) process by selling their shares on a public exchange. Assume that the companies have the same number of shares, that their return on equity is 20% and the cost of capital 10%.

Which company will command higher price per share from public investors?

Why?

Answer 1

Ans- company Y will command higher price as the company is planning for future growth and expansion It will create an opportunity for the investor and also it will multiply the shareholder wealth at a higher rate.

when a business grows it also generates revenue which is the income of the business which creates demand for the company's share in public investors it will lead to higher share price and more returns to shareholders.

On the other hand Company X divides there profits in the shareholders which means they have no retained earnings with them for future growth that is a drawback for investment in the company X