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29 Jan 2019

Miller and Modigliani (1961) argue that under certain assumptions a firm’s dividend policy will not affect the value of the firm. Required:

Drawing on relevant theories, critique Miller and Modigliani’s irrelevance proposition.

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Trinidad Tremblay
Trinidad TremblayLv2
1 Feb 2019

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Related questions

1. Which capital structure theory recognizes the fact that investors and managers do not have the same information regarding a firm’s prospects?

2. The capital structure that maximizes the stock price is also the one that the___________ WACC.

3. In Modigliani & Miller’s Proposition I with taxes the value of a levered firm is equal to the value of an unlevered firm plus____________ .

4. In Modigliani & Miller without taxes, what is the optimal debt to equity ratio?

5. The trade-off theory of capital structure states that debt initially adds value. Explain why

An unlevered firm has a market value of $10 million, with $1 million of its assets in cash. With 500,000 shares outstanding, its current stock price is $20.

a) Under the assumptions of Modigliani-Miller, what is the effect on the stock price of an announcement of a $1 special dividend to be paid in 6 months?

b) Find the new stock price after the ex-dividend date.

c) Assume that firm decides to repurchase $500,000 worth of stock instead. Under the assumptions of Modigliani-Miller, what happens to the share price after the repurchase takes place?

d) Assume now that the personal tax rate exceeds the capital gains tax rate. Will investors prefer the dividend or share repurchase? What happens to the stock price at announcement if the firm decides to pay a special dividend?

Which of the following statements regarding Modigliani and Miller (MM)’s propositions is most accurate?

A.

Firm value is maximized with a capital structure consisting of 100% equity

B.

The required rate of return of equity increases as the firm increases its financial leverage

C.

The use of debt financing increases the firm’s earnings volatility

D.

It does not matter which capital structure firm choose because capital structure is irrelevant in terms of firm value, with or without taxes.

E.

All of above are wrong

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