Question

1. Capital structure:
a. What are the capital structure theories?

b. The Miller and Modigliani proposition that dividend policy has no impact on the value of the firm fails to explain the accepted facts of dividend policy by major corporations. Explain the nature of Miller and Modigliani’s theory on dividend policy and outline its practical limitations.

Long explanations and discussions needed

Answer 1

1 a. Theories of capital structure can be classified into four types namely net operating income approach, traditional theory approach, Modigliani approach and net income approach.

b. As per Modigliani and Miller approach in terms of dividend policy it can be commented that there is no effect on the price of the shares in dividend policy. in addition, this also assumes that investment policy helps in increasing the value of the firm. In most of the cases, it has been seen that stakeholders of the organisation is satisfied with the earnings of the firm in the market as long as the earning is providing more equity capitalization rate. In miller theory it has been observed that there is different type of approach for valuation of shares. Limitations of Modigliani's and Miller theory are:

a. taxes are always present in capital market and perfect capital market do not exist.

b. There is not much difference between external and internal financing and floating cost of new shares are not ignored.

c. Shareholder's wealth do not effect the dividend. Transaction cost is generally considered by the investors in this context.

d. Dividend policy are not much affected by the condition of the market as the condition of the market is uncertain and future profit from the market is also uncertain.