As of December 31, 2005, two otherwise identical companies in the same industry, East Co. and West Co., have dividend payouts of 20% and 40%, respectively. Looking forward one year, which outcomes are least likely?
I. East Co. requires debt financing.
II. West Co. increases its dividend payout.
III. West Co.'s share price is twice that of East Co.
IV. East Co. repurchases outstanding shares.
A) I and II
B) II and IV
C) I, II and III
D) II, III and IV

Question

Quizplus · Accepted Answer

If East Co., with a lower dividend payout ratio, requires debt financing, it indicates that the company may have cash flow issues, and it would be less likely for it to happen. If West Co., with a higher dividend payout ratio, increases its dividend payout, it would be expected, and hence, more likely to happen. If West Co.'s share price is twice that of East Co., it may be an extreme scenario, as share prices depend on various factors, including dividend payouts. If East Co. repurchases outstanding shares, it is a common practice for companies to use excess cash for share buybacks. Therefore, the least likely outcomes are I, II, and III.

As of December 31, 2005, Two Otherwise Identical Companies in the Same