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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 question that follows: Sunny Corp. is an oil drilling company and has some free cash flow that is not expected to be used for growth or investment projects. The company plans to distribute to its shareholders but is still deciding whether they should conduct a stock repurchase or distribute dividends. Which of the folowing is a characteristic of a firm's optimal dividend policy? It maximizes the firm's stock price It maximizes the firm's total assets. It maximizes the firm's return on equity. It maximizes the firm's earnings per share 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 system encourages many individual investors to prefer dividends capital gains Some researchers and analysts have noticed a trend in which firms that increase their dividends see an increase in their stock price. The theory of explains this phenomenon. In some cases, analysts notice that groups of similar investors tend to flock to stocks that have dividend policies consistent with their needs. This circunstance is an illustration of Which of the following is a characteristic of a firm's optimal dividend policy? It maximizes the firm's stock price. It maximizes the firm's total assets. It maximizes the firm's return on equity. It maximizes the firm's earnings per share. 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 system encourages many individual investors to prefer Some researchers and analysts have noticed a trend in which firms that increase their dividends see an increase in their stock price. The theory of explains this phenomenon. clientele effed In some cases, analysts notice information content Vestors tend to flock to stocks that have dividend policies consistent with their needs. This circumstance is an ilustration of: The clientele effect The information content effect Despite some theoretical assertions, many investors do care a great deal about dividends. They believe that sure dividends today (a bird-in-the-hand) are less risky than a return in the form of capital gains in the future. The following table lists some factors that might affect an investor's preference for dividends. Indicate whether the given factors are likely to make an investor prefer to receive more or fewer dividends. Investors Will Likely Prefer... More Dividends Fewer Dividends Factor Investors expect a reliable annual cash flow from their stock portfolios. With capital gains, shareholders in high tax brackets have the ability to defer taxes into the future. Risk-averse investors prefer to minimize uncertainty with their expectations of income from their investment In examining investors' preferences for dividends, it is useful to begin with the concept of dividend irrelevance. Dividend irrelevance suggests that in a world with no brokerage costs or taxes, firms and investors are indifferent to the paying or receiving of dividends. However, as these restrictions are relaxed, various factors suggest that firms should pursue high or low payouts. One such factor is: Firms incur various legal and administrative costs (called flotation costs) when they issue new stock Based on the factor given, identify whether firms, in general, will tend to favour high or low payout ratios. O Favour a low payout Favour a high payout

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