CS Executive · Corporate Accounting and Financial Management · Dividend Decisions
According to the Modigliani-Miller (MM) dividend irrelevance hypothesis, what determines the value of a firm?
Under the MM hypothesis, firm value is determined by its earning power and investment policy. The split of earnings between dividends and retained earnings is irrelevant, because shareholders can adjust their own cash flows in a perfect capital market.
- AIts dividend payout ratio
- BIts earning power and investment policy, not how profits are split between dividends and retained earningsCorrect
- CThe proportion of retained earnings to paid-up capital
- DThe market rate of interest on debentures
Explanation
MM argue that in a perfect capital market, the value of a firm depends on its earning power and investment decisions. How earnings are divided between dividends and retention does not change value. Dividend payout ratio is therefore not a value driver under MM.
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