CFA CFA Level 2 Question of the Week: Level 2 – Corporate Finance

Question of the Week: Level 2 – Corporate Finance

  • Author
    Posts
    • MarkMeldrum
      Participant
      Up
      2
      Down

      According to Jensen’s free cash flow hypothesis, a company’s shareholders could decrease agency costs by demanding that management pay out all free cash flow as dividends.  Such a solution would most likely appear in which type of company?

      • A. Large-cap value stock.
      • B. Large-cap growth stock.
      • C. Small-cap growth stock.
    • MarkMeldrum
      Participant
      Up
      1
      Down

      The correct answer is Option A. 

      In general, it makes sense for small or growing companies in industries characterized by a rapid change to hold cash and pay low or no dividends but it does not make sense for large, mature companies in relatively non-cyclical industries.  Growth stocks need to reinvest in growth, whereas value stocks tend to generate strong free cash flow and have significantly fewer investment options.

Viewing 1 reply thread
  • You must be logged in to reply to this topic.