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    Question

    A company with stable earnings announces a sudden, large

    cut in dividend despite strong retained earnings and no capital expenditure needs. Which interpretation is most consistent with dividend signalling theory and market practice?
    A Market will view it positively—more cash for future projects. Correct Answer Incorrect Answer
    B Market may interpret cut as signal of future earnings weakness, causing a negative reaction. Correct Answer Incorrect Answer
    C No effect—dividends are irrelevant per Modigliani-Miller under all conditions. Correct Answer Incorrect Answer
    D Market will only react if share buybacks announced simultaneously. Correct Answer Incorrect Answer
    E The cut will cause immediate reclassification of debt to equity by lenders. Correct Answer Incorrect Answer

    Solution

    Dividend signalling suggests managers use dividend changes to signal private information about future earnings. An unexpected cut, especially with strong earnings and no investment need, is often interpreted as a negative signal.

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