Page 194 - 5.2 i. Manac Finance ITC Summarised Notes

THE DIVIDEND DECISION

Dividend policy is irrelevant in a perfect capital

market

• This theory, founded by Miller and Modigliani, states that the dividend

decision in a perfect capital market (no taxes, transaction costs or other
market imperfections) is irrelevant because investors are indifferent to
returns in the form of dividends or capital gains.

• The dividend policy of the company is irrelevant because the
shareholders create their own policy:

• If dividends are not paid and an investor needs cash they can either
sell their shares or borrow funds to restore their lost dividends.

• Alternatively, if a higher dividend is paid and the investor does not

want the extra cash they can re-invest the money.

This model states that a company first establishes its investment policy

and then how this is going to be financed. The entity should therefore
invest in projects with positive NPV’s and dividends are the residual figure
after making investments.

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