It has been shown that in the absence of taxes and other market imperfections firm value...

It has been shown that in the absence of taxes and other market imperfections firm value will be unaffected by dividend policy. Explain the logic behind this conclusion in a paragraph or two.

Expert Solution

The irrelevance of dividend policy for valuation of the firm has been most comprehensively presented by Modigliani and Miller (MM). They have argued that the market price of a share is affected by the earnings of the firm and is not influenced by pattern of income distribution. Modigliani – Miller theory goes a step further and illustrates the practical situations where dividends are not relevant to investors.

Assumptions of the model

1. Perfect capital market

2. No taxes

3. All information is freely available to all investors.

4. No transaction cost.

The model

Under the assumptions stated above, MM argue that neither the firm paying dividends nor the shareholders receiving the dividends will be adversely affected by firms paying either too little or too much dividends. They have used the arbitrage process to show that the division of profits between dividends and retained earnings is irrelevant from the point of view of the shareholders. They have shown that given the investment opportunities, a firm will finance these either by ploughing back profits of if pays dividends, then will raise an equal amount of new share capital externally by selling new shares. The amount of dividends paid to existing shareholders will be replaced by new share capital raised externally.

The benefit of increase in market value as a result of dividend payment will be offset completely by the decrease in terminal value of the share.The shareholders therefore will be indifferent between the dividend payment and retaining profits.

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jeff jeffy answered 2 years ago

It has been shown that in the absence of taxes and other market imperfections firm value...

It has been shown that in the absence of taxes and other market imperfections firm value will be unaffected by dividend policy. Explain the logic behind this conclusion. Next, describe three real-world factors that may cause one dividend policy to be preferable to another.

It has been shown that in the absence of taxes and other market imperfections firm value...

It has been shown that in the absence of taxes and other market imperfections firm value will be unaffected by dividend policy. Explain the logic behind this conclusion in a breif paragraph.

As discussed in the text, in the absence of market imperfections and tax effects, we would...

As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not necessarily true. One model has been proposed that incorporates tax effects into determining the ex-dividend price: (P0 – PX) / D = (1 – TP) / (1 – TG) Here P0 is the...

As discussed in the text, in the absence of market imperfections and tax effects, we would...

As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not necessarily true. One model has been proposed that incorporates tax effects into determining the ex-dividend price: (P0 – PX) / D = (1 – TP) / (1 – TG) Here P0 is the...

As discussed in the text, in the absence of market imperfections and tax effects, we would...

As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not necessarily true. One model has been proposed that incorporates tax effects into determining the ex-dividend price:1 (P0 – PX)/D = (1 – TP)/(1 – TG) where P0 is the price just before...

As discussed in the text, in the absence of market imperfections and tax effects, we would...

As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not necessarily true. One model has been proposed that incorporates tax effects into determining the ex-dividend price:1 (P0 – PX)/D = (1 – TP)/(1 – TG) where P0 is the price just before...

As discussed in the text, in the absence of market imperfections and tax effects, we would...

As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not necessarily true. One model has been proposed that incorporates tax effects into determining the ex-dividend price: (P0 – PX) / D = (1 – TP) / (1 – TG) Here P0 is the...

As discussed in the text, in the absence of market imperfections and tax effects, we would...

As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not necessarily true. One model has been proposed that incorporates tax effects into determining the ex-dividend price: (P0 – PX) / D = (1 – TP) / (1 – TG) Here P0 is the price...

As discussed in the text, in the absence of market imperfections and tax effects, we would...

As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not necessarily true. One model has been proposed that incorporates tax effects into determining the ex-dividend price: (PO – PX) / D = (1 – TP) / (1 – TG) Here PO is the price...

As discussed in the text, in the absence of market imperfections and tax effects, we would...

As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not necessarily true. One model has been proposed that incorporates tax effects into determining the ex-dividend price: (P0 – PX) / D = (1 – TP) / (1 – TG) Here P0 is the...

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It has been shown that in the absence of taxes and other market imperfections firm value...

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