An increase in share price following an increase in dividends is logical if the:
A) firm borrows to obtain cash for the dividend.
B) increased dividend signals higher future earnings.
C) dividend is believed to be temporary.
D) clientele effect is not important.

Question

Quizplus · Accepted Answer

An increase in dividends signals higher future earnings and is a positive signal to investors about the firm's future prospects, leading to an increase in share price. Option A is incorrect because borrowing to obtain cash for a dividend would be viewed negatively by investors. Option C is incorrect because a temporary dividend is unlikely to have a significant impact on share price. Option D is incorrect because the clientele effect, which refers to the preference of certain investors for stocks with specific characteristics such as high dividends, can still impact share price even if dividends increase.

An Increase in Share Price Following an Increase in Dividends