Question

Under Modigliani and Miller world, as the CEO of company, when you decided to distribute 1 Billion dollar cash, one of your shareholders, Mr. A, who purchased the stock on the ex-date, raised a concern that he will not be getting any dividend and he will be adversely affected by the distribution of the cash.

On the other hand, another shareholder, Mr. B, who was holding the stock before the ex-date argued that the earnings per share decreased and he is worse off because of the dividend payment.

What would be your answer to these shareholders? Do you agree or not agree with them? If you agree justify your answer. If you don’t agree, again justify your answer.

Answer 1

Ans ) Modigliani and Millar model in dividend distribution

Accordingto Miller and Modigliani Hypothesis or MM Approach, dividend policy has no effect on the price of the shares of the firm and believes that it is the investment policy that increases the firm's share value.

Assumptions of Miller and Modigliani Hypothesis

1. There is a perfect capital market, i.e. investors are rational and have access to all the information free of cost. There are no floatation or transaction costs, no investor is large enough to influence the market price, and the securities are infinitely divisible.
2. There are no taxes. Both the dividends and the capital gains are taxed at the similar rate.
3. It is assumed that a company follows a constant investment policy. This implies that there is no change in the business risk position and the rate of return on the investments in new projects.

Not agree