Question

Consider two very different firms, M and N. Firm M is a mature firm in a mature industry. Its annual net income and net cash flows are both consistently high and stable. However, M's growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new firm in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is correct?

a. Firm M probably has a higher dividend payout ratio than Firm N.

b. If the corporate tax rate increases, the debt ratio of both firms is likely to decline.

c. The two firms are equally likely to pay high dividends.

d. Firm N is likely to have a clientele of shareholders who want to receive consistent, stable dividend income. e. Firm M probably has a lower debt ratio than Firm N.

Answer 1

a. Firm M probably has a higher dividend payout ratio than Firm N

It is so because it has less growth opportunities and rather than investing will pay out income in dividends