Dividend Theory
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Based on what you know about dividend theory, evaluate the correctness of each of the following statements:
- a. If the dividend irrelevance theory (which is associated with Modigliani and Miller) were exactly correct, and if this theory could be tested with good data, then we would find in a regression of dividend yield and capital gains, a line with a slope of -1.0.
- b.The tax preference and bird-in-the-hand theories lead to identical conclusions as to the optimal dividend policy.
- c.If a company raises its dividend by an unexpectedly large amount, the announcement of this new and higher dividend is generally accompanied by an increase in the stock price. This is consistent with the bird-in-the-hand theory, and Modigliani and Miller used these findings to support their position on dividend theory.
- d. If it could be demonstrated that a clientele effect exists, this would suggest that firms could alter their dividend payment policies from year to year to take advantage of investment opportunities without having to worry about the effects of changing dividends on capital costs.
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- a. If the dividend irrelevance theory (which is associated with Modigliani and Miller) were exactly correct, and if this theory could be tested with good data, then we would find in a regression of dividend yield and capital gains, a line with a slope of -1.0.
This statement is correct. With dividend irrelevance policy we would conclude that the cost of equity would not change with dividend policy and that the investors would be indifferent between dividend yield and capital gains yield. Thus a regression between these two and so the slope would be constant at -1.0. It is minus since the total ...
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