Modigliani and Miller on the one hand, and Gordon and Linter on the other hand, have expressed strong views regarding the effect of dividend policy of a firms cost of capital and value. In this essence, what are the MM's and GL's views regarding the effect o dividend policy on the cost of capital and stock prices?

Modigliani and Miller on the one hand, and Gordon and Linter on the other hand, have expressed strong views regarding the effect of dividend policy of a firms cost of capital and value. In this essence, what are the MM's and GL's views regarding the effect o dividend policy on the cost of capital and stock prices?

Financial Reporting, Financial Statement Analysis and Valuation

8th Edition

ISBN:9781285190907

Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Chapter11: Risk-adjusted Expected Rates Of Return And The Dividends Valuation Approach

Section: Chapter Questions

Problem 8QE

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Modigliani and Miller (MM), on the one hand, and Gordon and Lintner (GL), on the otherhand, have expressed strong views regarding the effect of dividend policy on a firm’s costof capital and value.a. In essence, what are MM’s and GL’s views regarding the effect of dividend policy onthe cost of capital and stock prices?b. How could MM use the information content, or signaling, hypothesis to counter theiropponents’ arguments? If you were debating MM, how would you counter them?c. How could MM use the clientele effect concept to counter their opponents’ arguments?If you were debating MM, how would you counter them?
Which of the following theories is supported by the argument that shareholders can transform a company dividend policy into a different policy by means of investors buying and selling on their own account? a. dividend irrelevance theory b. "bird-in-the-hand" theory C. residual distribution model d. tax preference theory
One position expressed in the financial literature is that firms set their dividends as aresidual after using income to support new investment.a. Explain what a residual dividend policy implies, illustrating your answer with a tableshowing how different investment opportunities can lead to different dividend payoutratios.b. Think back to Chapter 14 where we considered the relationship between capital structureand the cost of capital. If the WACC-versus-debt-ratio plot was shaped like a sharp V,would this have a different implication for the importance of setting dividends accordingto the residual policy than if the plot was shaped like a shallow bowl (a flattened U)?
If the Modigliani and Miller hypothesis about dividends is correct, and if one found a group of companies which differed only with respect to dividend policy, which of the following statements would be most correct? Group of answer choices None of these statements is true. All of these statements are true. The total expected return, which in equilibrium is also equal to the required return, would be higher for those companies with lower payout ratios because of the greater risk associated with capital gains versus dividends. If the expected total return of each of the sample companies were divided into a dividend yield and a growth rate, and then a scatter diagram (or regression) analysis were undertaken, then the slope of the regression line (or b in the equation D1/P0 = a + b(g)) would be equal to +1.0. The residual dividend model should not be used, because it is inconsistent with the MM dividend hypothesis.
Which of the following statements is correct? A. The optimal dividend policy is the one that satisfies management, not shareholders. B. The use of debt financing has no effect on earnings per share (EPS) or stock price. C. Stock price is dependent on the projected EPS and the use of debt, but not on the timing of the earnings stream. D. The riskiness of projected EPS can impact the firm's value. E. Dlvidend policy is one aspect of the firm's financial policy that is determined solely by the shareholders. Reset Selection
What are the issues involve in implementing the divident growth model approach and the security market line approach in computing the cost of equity of a firm
What are the real-world factors that would encourage firms to follow a high dividend policy.
What effect would the calculation performed have in terms of shareholder value? In other words, suppose the company’s goal is to maximize shareholder value. How will the rate of return on equity (increase dividend per share by 1.75) support or inhibit that goal? Be sure to justify reasoning.
Two other interesting points brought up by Miller and Modigliani, as highlighted in Berk and DeMarzo (2020) were that “In perfect capital markets, investors are indifferent between the firm distributing funds via dividends or share repurchase” (p. 612) and that “In perfect capital markets, holding fixed the investment policy of a firm, the firm’s choice of dividend policy is irrelevant and does not affect the initial share price” (p. 614). Respond to this question by focusing on either dividend payout policy or the decision between stock repurchases and dividend payouts and illustrate how the assumptions made to support these axioms tend to oversimplify what occurs.
How should (a) signaling and (b) the clienteleeffect be taken into account by a firm as it considers its dividend decision? Do signaling and clientele effects make it easier or harder to determineif investors prefer high or low payout ratios? Dothese factors influence the desirability of a stabledistribution policy versus one that is flexible andthus varies with the company’s cash flows andinvestment opportunities?
The residual dividend approach is the best dividend policy to adopt if a firm’s management wants to maximize the current value per share of the existing stock. Do you agree or disagree with this statement? State and justify your conclusions.
A firm’s value depends on its expected free cash flow and its cost of capital. Distributions made in the form of dividends or stock repurchases impact the firm’s value and the investors in different ways. Some analysts have argued that a firm’s value should solely be determined by its basic earning power and the business risk of the firm. Which of these concepts would support these analysts’ argument? The signaling hypothesis The residual dividend model The clientele effect Dividend irrelevance theory