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Describe how capital gains and dividend growth affect stock prices. What would be a reason that...

Describe how capital gains and dividend growth affect stock prices. What would be a reason that a firm may choose not to pay dividends?

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Answer #1

Higher capital gains and higher dividend growth leads to higher stock prices. The stock price is calculated by discounting future dividends by an appropriate rate of return.

By opting to not pay dividends, the firm reinvests the earnings in investments that have positive Net Present Value, which increases the value of the firm. This increases the growth rate of free cash flows.

Another reason a firm may choose not to pay dividends is to avoid dividend distribution taxes. A firm may choose to buy back its shares, which may be an efficient way to give excess cash to the shareholders.

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