If a firm has a positive NPV project but cannot raise equity or capital to do it, then it can obtain the funds by temporarily cutting its regular dividends and this will generally have little or no impact on its stock price.

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BlackTom AI · Accepted Answer

The statement presents a scenario where a firm with a positive NPV project cannot raise external equity or debt, and proposes funding the project by temporarily cutting regular dividends, claiming this would have little or no impact on the stock price.

First, consider what cutting dividends implies. Dividends are part of the total return that investors expect from holding the stock. A decision to reduce or suspend dividends often signals to investors that the firm faces financial constraints or expects weaker future cash flows. This signaling can lead to a negative revaluation of the stock, causing the price to fall as investors adjust their expectations.

Second, even if the project has positive NPV, financing it by cutting dividends changes the firm’s payout policy and capital structure. Shareholders may view reduced dividends as a higher risk that the firm will under-deliver on its cash-return promises, or as a sign that management cannot fund value-enhancing opportunities with internally generated cash or cheaper external financing. This can depress the stock price.

Third, cutting dividends can affect the stock’s appeal to income-focused investors. Those investors may sell or demand higher expected returns to compensate for the loss of predictable income, exerting downward pressure on price.

Fourth, the assumption that funding a positive-NPV project via dividend cuts will have little impact ignores the trade-offs between dividend policy, signaling, and leverage. While it is possible that in some cases the market might view the move neutrally, the typical market reaction tends to be negative or at least not favorable because it signals financing distress and alters shareholder value perception.

In sum, the claim that temporarily cutting dividends to fund a positive-NPV project will generally have little or no impact on stock price is not consistent with common financial theory and market behavior, where dividend cuts can be interpreted as negative signals and may reduce the stock’s value.

COMM_V 370 101-108 2025W1 COMM 370 2025W1 - Practice Final

If a firm has a positive NPV project but cannot raise equity or capital to do it, then it can obtain the funds by temporarily cutting its regular dividends and this will generally have little or no impact on its stock price.

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