Question

Which of the following is true with respect to Miller-Modigilani model on dividend policies?

• A. If the firm declares dividends the share price goes up
• B. If the firm declares dividends the share prices comes down once retained earning decrease
• C. The market value of the shares is not affected by dividend policy
• D. The share prices goes up only when the dividends grow at a fixed rate
• E. Share prices influenced not only by dividend policy but by a host of other factors too

Answer 1

The correct option is C The market value of the shares is not affected by dividend policy

If the firm distributes its earnings as cash dividends then it will have to raise capital for financing its investment by selling new shares. Here, the arbitrage process will neutralize the increase in the share value due to the cash dividends by the issue of additional shares. Hence, the market value of the share is not affected by the dividend policy.