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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

Modigliani and Miller (MM), on the one hand, and Gordon and Lintner (GL), on the other hand, have expressed strong views regadring the effect of dividend policy on a firm’s cost of capital and value.

  1. a. In essence, what are MM’s and GL’s views regarding the effect of dividend policy on the cost of capital and stock prices?
  2. b. How could MM use the information content, or signaling, hypothesis to counter their opponents' arguments? If you were debating MM, how would you counter them?
  3. c. How could MM use the clientele concept to counter their opponents’ arguments? If you were debating MM, how would you counter them?

a.

Summary Introduction

To determine: The MM and GL view regarding the effect of dividend policy on the cost of capital and on stock prices.

Introduction:

Modigliani and Miller Approach (MM):

The Modigliani and miller approach can be used for the dividend decision. This approach is an addition to the net operating income approach. As per this approach, the valuation of a firm is not relevant to the capital structure decisions.

Gordon and Lintner Approach (GL):

Gordon and Linter Approach is also known as the bird in the hand approach. As per this approach, the current expected dividend of the company is relevant to the valuation of value of firm.

Explanation

MM view:

  • As per MM view, the dividend policy will not play any role in the valuation of cost of capital and stock prices.
  • As per MM approach, the investment policy of the company is always fixed.
  • MM says that earning of the company directly affect the valuation of the company...

b.

Summary Introduction

To discuss: MM’s view point to counter GL’s statement.

c.

Summary Introduction

To discuss: To counter GL’s statement by putting clientele concept.

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