Such perfect markets do not exist in the practical world. MM model assumes that there are perfect capital markets. Some of the problems of MM approach are due to imperfect markets, transaction costs, floatation costs and uncertainty of future capital gains and the preference for current dividends. Their assumptions appear to be unrealistic and unpractical although theoretically it is appealing. According to them, retained earnings and external financing balance each other. Modigliani and Miller have argued that it makes no difference to the investors if a firm retains earnings or declares a dividend.
Thus, whether dividends are paid or not paid the value of the firm is the same. Number of new shares to be issued in both cases: Price of the share at the end of the year 1Īmount required to be raised from the issue of new shares.Īmount required to be raised from the issue of new shares: (2) Value of the firm when dividends are not paid. Or, Total number of shares X market price of the share = 22, 857 x 105 = 23,99,985 rounded of to Rs. (c) Number of additional shares to be issuedĮxisting shares equals 20,000 + new shares 2857 = 22,857 (b) Amount required to be raised from the issue (1) Value of the firm when dividends are paid What will be the value of the firm’s share at the end of the year if (i) a dividend is not declared, and (ii) assuming that the firm pays a dividend how many shares must be issued? Use M.M. 2, 00,000 and proposes to make new investments of Rs. The company expects to have a net income of Rs. 5 per share at the end of the current financial year. The firm is planning to declare dividend of Rs. A company has an equity capitalization rate of 10%. hypothesis concludes that dividends do not count and that the dividend has no effect on the share price. Since Dividend D are not found in Step 5, M.M. E = Earnings of the firm during the period.Įquation 4 states that whatever investment needs (C) are not financed by retained earnings, must be through the sale of additional equity shares.
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