Transaction and Inconvenience Costs

Transaction and Inconvenience Costs Yet another assumption which is open to question is that there are no transaction costs in the capital market. Transaction costs refer to costs associated with the sale of securities by the shareholder investors. The costs postulate implies that if dividend are not paid for earnings are retained, the investors desirous of current income to meet consumption needs can sell a p

Flotation Cost

Flotation Cost Another assumption of a perfect capital market underlying the MM hypothesis is dividend irrelevance is the absence of flotation costs. The flotation cost refers to the cost involved in capital from the market, for instance, underwriting commission, brokerage and other expenses. The presence of flotation costs affects the balancing nature of internal (retained earnings) and external (dividend pa

Tax Effect

Tax Effect An assumption of the MM hypothesis is that there are no taxes. In implies that retention of earnings (internal financing) and payment of dividends (external financing) are, from the viewpoint of tax treatment, on an equal footing. The investors would find both forms of financing equally desirable. The tax liability of the investors, broadly speaking, is of two types: (i) tax on dividend income, and

A Critique

A Critique Modigliani and Miller argue that the dividend decision of the firm is irrelevant in the sense that the value of the firm is independent of it. The crux of their argument is that the investors are indifferent between dividend and retention of earnings. This is mainly because of the balancing nature of internal financing (retained earnings) and external financing (raising of funds externally) consequent

Crux of the Argument

Crux of the Argument The crux of the MM position on the irrelevance of dividend is arbitrage argument. The arbitrage process involves a switching and balancing operation. In other words. arbitrage refers to entering simultaneously into two transactions which exactly balance completely offset each other. The two transactions here are the acts of paying out dividends raising external funds either through the sale


Assumptions The MM hypothesis of irrelevance of dividends is based on the following assumptions: 1. Perfect capital markets in which all investors are rational information is available to of cost, there are no transactions costs, securities are infinitely divisible, no investor enough to influence the market price of securities, there are no notation costs. 2. There are no taxes. Alternatively, there are no diff

Modigliani and Miller (MM) Hypothesis

Modigliani and Miller (MM) Hypothesis The most comprehensive argument in support of the Irrelevance of dividends is provided MM hypothesis. Modigliani and Miller maintain that dividend policy has no effect on the price of the firm and is, therefore. of no consequence. What matters, according to them, investment policy through which the firm can increase its earnings and thereby the value firm. Given the investm


IRRELEVANCE OF DIVIDENDS General The crux of the argument supporting the irrelevance of dividends to valuation is that the dividend policy of a fum is a part of its financing decision. As a part of the financing decision, the dividend policy of the firm is a residual decision and dividends are a passive residual. If dividend policy is strictly a financing decision, whether dividends are paid out of profits, or e


DIVIDEND AND VALUATION INTRODUCTION Dividends refer to that portion of a firm’s net earnings which are paid out to the shareholders. Our focus here is on dividends paid to the ordinary shareholders because holders of preference shares are entitled to a stipulated rate of dividend. Moreover, the discussion is relevant to widely held public limited companies as the dividend issue does not pose a major proble