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Question
Which one of the following is not among the assumptions of the Modigliani-Miller model?
Which one of the following is not among the assumptions of the Modigliani-Miller model?
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Solution
The correct option is C Unity for dividend payout ratio
According to Modigliani and Miller (M-M), dividend policy of a firm is irrelevant as it does not affect the wealth of the shareholders. They argue that the value of the firm depends on the firm’s earnings which result from its investment policy.
Modigliani and Miller model is based on the following assumptions :
1. The firm operates in perfect capital market.
2.The firm has a fixed investment policy.3. Absence of taxes.4. Risk of uncertainty does not exist. That is, investors are able to forecast future prices and dividends with certainty and one discount rate is appropriate for all securities and all time periods.
According to Modigliani and Miller (M-M), dividend policy of a firm is irrelevant as it does not affect the wealth of the shareholders. They argue that the value of the firm depends on the firm’s earnings which result from its investment policy.
Modigliani and Miller model is based on the following assumptions :
1. The firm operates in perfect capital market.
2.The firm has a fixed investment policy.
3. Absence of taxes.
4. Risk of uncertainty does not exist. That is, investors are able to forecast future prices and dividends with certainty and one discount rate is appropriate for all securities and all time periods.
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