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CMA Intermediate · Financial Management and Business Data Analytics · Dividend Decisions and Dividend Theories

Which of the following is an assumption of the Modigliani-Miller (MM) dividend irrelevance theory?

MM dividend irrelevance assumes perfect capital markets with no taxes, no flotation or transaction costs, rational investors and a given investment policy. Under these conditions dividend policy does not affect firm value. Preferences for dividends or tax differences are outside the theory.

  1. APerfect capital markets with no taxes and no flotation costsCorrect
  2. BRetained earnings are always cheaper than new equity because of flotation costs
  3. CDividends are taxed at a higher rate than capital gains
  4. DInvestors prefer current dividends to uncertain future capital gains

Explanation

MM assumes perfect capital markets, no taxes, no transaction or flotation costs, rational investors and a fixed investment policy. The other options describe tax-preference, flotation-cost or bird-in-the-hand views, which contradict the MM setting.

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