A firm’s value depends on its expected free cash flow and its cost of capital

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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 questions that follow:

Hackworth Oil Company 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.

1.) Which of the following is a characteristic of a firm’s optimal dividend policy?

a. It maximizes the firm’s earnings per share.

b. It maximizes the firm’s total assets.

c. It maximizes the firm’s return on equity.

d. It maximizes the firm’s stock price.

2.) Modigliani and Miller argued that each shareholder can construct his or her own dividend policy. This statement is:

a. True

b. False

Modigliani and Miller also pointed out that many institutional investors do not pay taxes and can buy and sell stocks with very low transaction costs. For these investors, dividend policy is 3.) ___________ relevant than it is for an individual investor.

Choices for no. 3:

a. less

b. more