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    Dividend Policy and Optimal Level of Debt

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    Modigliani and Miller have postulated that dividend policy is basically irrelevant in that if a firm is growing (share value would demonstrate this) then an internal dividend is created and the investor may sell shares to capture this dividend.

    1. Do you agree with this statement? Why or why not?
    2. What difference might it make to an investor if the dividend is either in cash or in shares of stock?
    3. What impact does a share split have on the valuation of a firm?

    Using debt has tax advantages for a firm, but there is a trade-off with regard to debt service (interest payments on accrued debt).

    1. If you were a member of senior management for Johnson & Johnson, what factors might you consider when deciding upon an optimal level of debt?
    2. What metrics (ratios or other quantitative measures) might assist you in this consideration?

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    https://brainmass.com/business/dividends-stock-repurchase-and-policy/dividend-policy-optimal-level-debt-515229

    Solution Preview

    Hi,

    Answer:
    Modigliani and Miller have postulated that dividend policy is basically irrelevant in that if a firm is growing (share value would demonstrate this) then an internal dividend is created and the investor may sell shares to capture this dividend.

    a) I don't agree with this statement as far as the real world is concerned. Modigliani and Miller's statement is based on certain factors that don't hold true in the real world. These assumptions are:

    (i) Perfect capital market exists

    In the real world a perfect capital market doesn't exist because investors have to pay to get information and there is transaction and floatation cost involved in investments.

    (ii) Zero Tax environment.

    Investors throughout ...

    Solution Summary

    This solution discusses Modigliani's and Miller's postulations about corporate dividends policy and addresses several questions on the topic. Additionally, this solution includes a brief outline of the factors to consider when determining the optimum debt level for an organization to carry.

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