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Dividend policy

Theories of dividend policy

Should an organisation pay out a regular dividend or use the cash to fund further
investment?

1.1 Dividend irrelevancy theory (Modigliani & Miller)

Assumptions

 There exists a perfect capital market

 There are no transaction costs

 There are no taxes or dividends and capital gains are taxed in the same way

Theory

The pattern of dividend payouts should be irrelevant. As long as
companies continue to invest in positive NPV projects, the wealth of the
shareholders should increase whether or not the company makes a
dividend payment in the year.

Modigliani and miller (M&M) suggested that entities should focus on
investment policy rather than dividend policy and that if investors
required income, they could sell shares to ‘manufacture’ dividends.

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