Question

1. Tax effect theory of dividend payout assumes that

   		a.Dividends are taxed at a lower rate than capital gains tax
   		b.Dividends are taxed at a higher rate than capital gains tax
   		c.Investors prefer higher dividend payout
   		d.Investors are indifferent to dividend payment.

Answer 1

Correct answer is B.

Dividends are taxed at a higher rate than capital gains tax.

It claims that investors prefer lower payout companies for tax reasons. As unlike dividend, long-term capital gains allow the investor to defer tax payment until they decide to sell the stock. Also, dividends are taxed at a higher rate than capital gains tax.Therefore, investors might want the companies to retain their earnings in order to avoid higher taxes and investors prefers low dividend payout.