Question

If the dividend relevance theory is valid, which of the following statements must be correct?

A. Stockbolders who prefer to earn capital gains on their investments rather than to receive dividends are not concerned with whether a firm pays dividends because such decisions do not affect the market price of its stock

B. A retired individual is more likely to invest in the stock of a company to earn capital gains than to get paid dividends.

C. Stockholders who prefer to receive annual dividends rather than to earn capital gains on their investments are not concerned with whether a firm invests in acceptable capital budgeting projects because such decisions do not affect the annual income generated by the firm and thus the dividends that are paid

D. Stockholders who prefer to earn capital gains on their investments would like the firm to retain and reinvest any free cash flows that it generates

E. If most of the stockholders of a firm prefer to receive current income rather than to earn capital gains on their investments, the firm can reduce its required return on equity by increasing the dividend payout

Answer 1

Option is E

If most of the stockholders of a firm prefer to receive current income rather than to earn capital gains on their investments, the firm can reduce its required return on equity by increasing the dividend payout.

because after payout the dividend, less amount would be left for reinvestment and investors expected rate of return would be declined due to less risk involved and fund vested with the company. A higher payout reduces the reinvestment risk of funds thus reducing required rate of return on equity.