Which of the following factors is most likely to explain why a company decides to pay...

Which of the following factors is most likely to explain why a company decides to pay dividends?

The firm has a large number of desirable projects.

The firm has poor cash flows

A large proportion of its shares are owned by investors who prefer dividends

The issuance cost of equity is high

Expert Solution

The factor that a large proportion of its shares are owned by investors who prefer dividends is the correct option.

The objective of a firm is to maximise the return to shareholders.The decision to pay divdends is going to maximise the wealth of the investors who prefer dividend and this will increase the share value of the firm. The firm can also go for new share issues with a premium pricing by utilizing the market reputation. So option 3 is correct.

The firm will not decide to pay dividend when it has large no of desirable projects, it would like to retain earnings to use for the projects as retained earning is the cheaper source of fund. So option 1 in wrong.

If the firm has poor cash flow , it cannot pay dividend easily, so option 2 is wrong.

If the issuance cost of equity is high , the firm will tend to use the reained earning as it has no floatation cost , so it will not go for dividend payment. So option 4 is also wrong.

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