CA Intermediate · Financial Management and Strategic Management · Dividend Decision
Under the Modigliani-Miller (MM) dividend irrelevance hypothesis, the market value of a firm depends on which of the following?
Under the MM hypothesis, firm value depends on earning power and investment policy, not on the dividend payout ratio. In a perfect market, investors can create homemade dividends by selling shares, so the split between dividends and retained earnings does not affect value.
- AIts earning power and investment policy, not the dividend payout ratioCorrect
- BThe dividend payout ratio chosen by the board
- CThe retention ratio alone
- DThe dividend yield expected by shareholders
Explanation
MM argue that in a perfect capital market with no taxes or transaction costs, value is determined by the firm's earning power and investment decisions. How earnings are split between dividends and retention does not change value, as shareholders can create homemade dividends. The payout ratio options therefore contradict the hypothesis.
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