Chartered Financial Analyst Level 2

Explanation

A dividend increase is most likely viewed as a positive signal by shareholders for an undervalued manufacturing company (Option B).

Analysis of Each Option:

Option A: A retailer facing financial pressure

• A dividend increase when a company is under financial pressure would be viewed negatively
• It signals poor capital allocation decisions and potential financial distress
• Shareholders would prefer the company conserve cash rather than pay dividends

Option B: An undervalued manufacturing company

• ✓ CORRECT ANSWER: A dividend increase signals management's confidence in future cash flows
• For undervalued companies, it demonstrates financial strength and commitment to shareholders
• It can signal that the company has stable earnings and strong cash generation capabilities

Option C: A fast growing tech company planning to raise equity

• A dividend increase would be contradictory for a fast-growing company needing capital
• Shareholders would prefer reinvestment in growth opportunities rather than dividend payments
• It would signal that the company lacks profitable investment opportunities

Key Concept:

Dividend signaling theory suggests that dividend increases convey positive information about management's confidence in future earnings and cash flows, particularly for mature, stable companies with undervalued stock.