Podcast Beta
Questions and Answers
According to Modigliani and Miller model, how is the current market value of a company shares affected by the dividend policy?
What is a criticism of the Modigliani and Miller dividend irrelevancy theory related to tax in the real world?
What assumption of Modigliani and Miller model is criticized due to the existence of transaction costs in the real world?
The Dividend Clientele Effect is based on the assumption that dividend policy is not a determining factor in what?
Signup and view all the answers
In the context of Modigliani and Miller model, what does the assumption about borrowing rates for companies and individuals imply?
Signup and view all the answers
Which aspect of Modigliani and Miller's dividend irrelevancy theory is criticized due to the lack of free tax status in the real world?
Signup and view all the answers
What does Modigliani and Miller model assume about obtaining information on company investment plans in a perfect market situation?
Signup and view all the answers
What aspect of Modigliani and Miller's theory is criticized due to the absence of perfect market conditions in reality?
Signup and view all the answers
Study Notes
Dividend Policies
- Different companies follow different dividend policies based on their investment needs and circumstances.
- Companies may decide on a lower or higher dividend payout depending on their needs.
Investor Preferences
- Different shareholders have different needs in terms of expected returns from their investments.
- Some investors prefer current dividends, while others prefer future capital gains.
- Investors who prefer current dividends tend to invest in companies with generous dividend payouts.
- Investors who prefer future capital gains tend to invest in companies with lower dividend payouts.
Tax and Dividends
- Tax is a compulsory levy imposed by the government on individual or corporate income.
- Firms pay tax on their net profit before interest and taxes.
- Dividend payments are made out of earnings after interest and tax.
- There is no correlation between corporate taxes and gross dividend declared.
- For individual investors, there is a positive correlation between dividend income received and taxes paid.
- The effect of taxes on dividend income and capital gains is weighed between the dividend income tax rate and capital gain tax rate.
Dividend Policy and Firm Value
- A firm's dividend policy affects its retained earnings and the taxes paid by investors.
- A firm with a high dividend payout will have lower retained earnings and investors will pay more taxes.
- A firm with a low dividend payout will have higher retained earnings and investors will pay less taxes, increasing the firm's value and expected capital gains.
Modigliani and Miller Model
- The model suggests that the current market value of a company's shares is not affected by its dividend policy.
- The model is based on certain assumptions, including a free tax world, no transaction costs, and perfect market conditions.
Criticism of Modigliani and Miller Model
- The model's assumptions can be criticized for not reflecting real-world conditions, such as the existence of taxes and transaction costs.
- The model assumes that companies and individuals can borrow at the same rate of interest, which is not realistic.
- The model also assumes that relevant information about company investments can be obtained cost-free, which is not possible.
Dividend Clientele Effect
- The dividend clientele effect suggests that dividend policy is not an active variable in determining a company's value.
- The effect is based on the assumption that investors are attracted to companies with dividend policies that match their preferences.
Studying That Suits You
Use AI to generate personalized quizzes and flashcards to suit your learning preferences.
Description
Test your knowledge on how companies decide on dividend policies and how different shareholders may have varying preferences for expected returns. Explore the factors influencing dividend payouts and investor choices.
