CFA® Level 1 Exam: Which Statement is Most Correct?

Which of the following statements is most correct?

Prev Question Next Question

Question

Answers

A. Stock splits reduce the number of shares outstanding.

B. A key advantage of the residual dividend policy is that it usually results in a stable dividend policy, which is attractive to investors.

C. A reduction in the capital gains rate should work to discourage corporations from repurchasing their shares.

D. The bird-in-hand theory of dividends suggests that firms that increase their dividend payout should expect to realize a higher share price and a lower cost of equity capital.

Show Answer

Explanations

Click on the arrows to vote for the correct answer

A. B. C. D.

The main conclusion of MM's irrelevance theory is that dividend policy does not affect the required rate of return on equity. Gordon-Lintner disagreed stating that k

(s) decreases as the dividend payout is increased because investors are less certain of receiving the capital gains which should result from retaining earnings than they are of receiving dividends. They said that investors value expected dividends more highly than expected capital gains because the dividend yield is less risky than the growth component in the total expected return equation, k(s) = D1/Po + g. MM disagreed and theorized that k(s) is independent of dividend policy, implying that investors are indifferent between dividends and capital gains. MM called the Gordon-Lintner's study the bird-in-the- hand fallacy, because MM thought the riskiness of the firm's cash flows to investors in the long run is determined by the riskiness of the operating cash flows, not by dividend policy.

Prev Question Next Question