Toronto Skaters Company has cash flows 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 the M&M theory, the value of the firm is determined by its investment policy, not by its dividend policy. Therefore, reducing the dividend should not affect the value of the firm. However, if the company reinvests the funds saved from reducing the dividend in profitable opportunities and generates a return greater than the return required by the shareholders, then the value of the firm will increase. Therefore, choice C is the best answer.

Toronto Skaters Company Has Cash Flows from Operations of $100