Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50%
ID: 2707135 • Letter: S
Question
Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument. True False Suppose a firm that has been earning $2 and paying a dividend of $1.00, or a 50% payout, announces that it is increasing the dividend to $1.50. The stock price then jumps from $20 to $30. Some people would argue that this is proof that investors prefer dividends to retained earnings. Miller and Modigliani would agree with this argument. True FalseExplanation / Answer
HI HesitantPlumber6075,
WITH REFERENCE TO YOUR QUESTION THE ANSWER IS AS FOLLOWS:-
ASSUMPTIONS OF MM MODEL:-
a] PERFECT CAPITAL MARKETS
b]RATIONAL INVESTORS
c]NO TAXES , NO TRANSACTION COSTA,NO FLOATATION COST.
d]NO RESTRICTIONS ON SHORT-SELLING.
e]SHARES ARE FULLY DIVISIBLE ( i.e. FRACTIONAL SHARES ARE ALLOWED)
UNDER THESE RESTRICTIVE SET OF ASSUMPTIONS , MM ARGUES THAT DIVIDEND POLICY IS IRRELEVANT.HE PUTS FORWARD THE ARGUMENT OF "HOME-MADE DIVIDEND".
CONSIDER TWO SHAREHOLDERS A & B EACH HOLDING 100 SHARES OF X LTD. PRESENTLY TRADING AT $200 EACH. A DESIRES DPS OF $10 WHILE B DESIRES DPS OF $20 . X LTD. PAYS A DPS OF $15. BOTH A& B CAN ACHIEVE THEIR DESIRE BY TRADING IN SHARES :--
*** A SHOULD BUY 2.5 SHARES [(15-10)*100 / 200]
***B SHOULD SELL 2.5 SHARES
THUS BOTH OF THEM DO NOT DEPEND UPON THE COMPANY'S DIVIDEND POLICY.SO, DIVIDEND POLICY IS IRRELEVANT.
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