Dividend theories - Dividend decision By Aditi Yadav...

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Dividend decision By: Aditi Yadav
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DIVIDEND DECISION The value of the firm can be maximized if the shareholder’s wealth is maximized. There is conflicting view regarding the impact of dividend decision on the valuation of firm. According to one school of thought, dividend decisions does not affect share-holder’s wealth and hence the valuation of firm. On the other hand, according to other school of thought, dividend decision materially affect the shareholder’s wealth and also the valuation of the firm.
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Views of two schools of thoughts are discussed below under two groups:- 1) Theory of IRRELEVANCE 2) Theory of RELEVANCE
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1) The irrelevance concept of dividend : A. Residual Approach : This theory regards dividend decision merely as the part of financial decision because the earning available may be retained in the business for re-investment. But if the funds are not required in the business they may be distributed as dividend. This theory assume that investor do not differentiate between dividend and retention by the firm.
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B. Modigliani and Miller approach: They mentioned that dividend policy has no effect on the market price of shares and the value of the firm is determined by the earning capacity of the firm or its investment policy. The splitting of earning between retentions and dividend in any manner the firm’s likes, does not affect the value of firm.
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Assumptions of MM hypothesis There are perfect capital market. Investors behave rationally. Info about the company is available to all without any cost. There are no flotation or transaction cost. No investor is large enough to effect the market price of share. The firm has rigid investment policy. There are either no tax or no difference in tax rates applicable to dividend and capital gain. There is no risk or uncertainties regard to the future of the firm. (MM dropped this
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The argument of MM The argument given by MM in support of their hypothesis is that whatever increase in the value of the firm results from the payment of dividend, will be exactly offset by the decline in market price of shares because
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  • Spring '17
  • Dividend, Price per share

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