Page 12 - PowerPoint Presentation

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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