Montreal Skaters Company has cash flow from operations of $100 million.Usually it pays a total annual dividend of $100 million.In an M&M world, can reducing the dividend result in an increase in the value of the firm?
A)No, according to M&M dividends are irrelevant so there should be no change in the value of the firm.
B)No, in fact it will decrease value because shareholders like dividends more than capital gains.
C)Yes, as long as the yield on the new investments the firm makes is greater than the return required by the shareholders.
D)Yes, because shareholders like capital gains more than dividends.

Question

Quizplus · Accepted Answer

According to M&M theory, the value of the firm is determined by its cash flows, and dividends are irrelevant. Therefore, reducing the dividend should have no effect on the value of the firm. However, if the firm invests the retained earnings in new projects that yield a return greater than the shareholders' required rate of return, then the value of the firm will increase. Thus, the correct answer is C.

Montreal Skaters Company Has Cash Flow from Operations of $100