Chartered Financial Analyst Level 2
Get started today
Ultimate access to all questions.
Deep dive into the quiz with AI chat providers.
We prepare a focused prompt with your quiz and certificate details so each AI can offer a more tailored, in-depth explanation.
- With respect to theories of dividend policy, Miller and Modigliani argue that investors:
Exam-Like
Community
LLeetQuiz
A
are indifferent between cash dividends and share repurchases.
B
prefer a dollar of dividends to a dollar of potential share capital gains from reinvesting earnings.
C
prefer a dividend payout ratio that is as low as possible when dividends are taxed at higher rates than capital gains.
Explanation:
Explanation
Miller and Modigliani's dividend irrelevance theory states that in a perfect capital market (without taxes, transaction costs, or information asymmetry), investors are indifferent between receiving dividends and capital gains. This is because:
- Dividend irrelevance: The value of a firm is determined by its earning power and investment policy, not by its dividend policy
- Homemade dividends: Investors can create their own dividend policy by selling shares if they want cash, or reinvesting dividends if they want growth
- No preference: In perfect markets, a dollar of dividends is equivalent to a dollar of capital gains
Why other options are incorrect:
- Option B: This contradicts Miller and Modigliani's theory, as they argue investors are indifferent, not that they prefer dividends
- Option C: This relates to tax clientele effects, which Miller and Modigliani did not address in their original theory (they assumed perfect markets without taxes)
Key Insight: Miller and Modigliani's theory is foundational in corporate finance, establishing that dividend policy doesn't affect firm value in perfect capital markets.
Comments
Loading comments...