An unlevered firm has a market value of $10 million, with $1 million of its asse

Question

An unlevered firm has a market value of $10 million, with $1 million of its assets incash. With 500,000 shares outstanding, its current stock price is $20.a) Under the assumptions of Modigliani-??Miller, what is the effect on thestock price of an announcement of a $1 special dividend to be paid in 6

months?

b) Find the new stock price after the ex-??dividend date.

c) Assume that firm decides to repurchase $500,000 worth of stock instead.Under the assumptions of Modigliani-??Miller, what happens to the share

price after the repurchase takes place?

d) Assume now that the personal tax rate exceeds the capital gains tax rate.Will investors prefer the dividend or share repurchase? What happens tothe stock price at announcement if the firm decides to pay a special

dividend?

e) Suppose that firm announces that it will pay a dividend continuouslyinstead of a one-??time special dividend. In the real world (i.e. Modigliani-??Miller no longer holds), how would you predict stock price to respond?

Explain.

Please hel with this. I have finals coming up and I'm having some difficulties with problem sets.

Explanation / Answer

According to Modigliani and Miller (M-M), dividend policy of a firm is irrelevant as it does not affect the wealth of the shareholders. They argue that the value of the firm depends on the firm

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