The manager of XYZ Corp.feels that a dividend increase will increase the stock price because many investors value stock with a dividend-discount model.Why might MM disagree with this assertion?
A) The increased dividend makes the firm much riskier.
B) If investment policy is to remain unchanged, the company will need to replace the cash with a stock issue.
C) Investors prefer capital gains over dividends.
D) Dividend increases will increase the book value but not the market value of the firm.

Question

Quizplus · Accepted Answer

According to the Modigliani-Miller dividend irrelevance theory, in a perfect market, a company's dividend policy should have no effect on the stock price or the value of the company. This is because investors can create their desired cash flows through selling shares or reinvesting dividends. Therefore, MM would argue that increasing dividends would not necessarily increase the stock price, as investors could alternatively choose to sell shares to create their desired cash flows rather than receiving cash from dividends. Additionally, if the company wishes to maintain its current investment policy, it would need to replace the cash used to pay dividends through issuing new shares, which could dilute the value of existing shares.

The Manager of XYZ Corp