Mm Approach

Qus4. What ar the assumptions of MM commence? Ans. confidence of the MM approach The MM approach to irrelevance of dividend is based on the hobby assumptions * The capital commercialises are perfect and the investors act rationally. * All information is freely gettable to all the investors. * There is no work cost. * Securities are divisible and place be split into any fraction. No investor can affect the market price. * There are no taxes and no flotation cost. The unwavering has a defined investment insurance and the future bread are know with certainty. The implication is that the investment decisions are immune by the dividend decision and the operating capital flows are same no study which dividend policy is adopted. The model Under the assumptions verbalise above, MM argue that n either the trus dickensrthy paying dividends nor the shareholders receiving the dividends volition be adversely affected by dissolutes paying either in any case little or too much di vidends.They have used the trade process to show that the division of profits between dividends and retained earnings is unlike from the point of view of the shareholders. They have shown that granted the investment opportunities, a incorruptible volition finance these either by go back profits of if pays dividends, then go forth raise an equal essence of fresh share capital externally by selling new shares. The amount of dividends gainful to existing shareholders will be replaced by new share capital brocaded externally.In order to satisfy their model, MM has started with the chase valuation model. P0= 1* (D1+P1)/ (1+ke) Where, P0 = Present market price of the share Ke = Cost of comeliness share capital D1 = anticipate dividend at the end of year 1 P1 = Expected market price of the share at the end of year 1 With the back up of this valuation model we will arrive at a arbitrage process, i. e. , replacement of amount paid as dividend by the expiration of fresh cap ital.The arbitrage process involves twain simultaneous actions. With reference to dividend policy the two actions are * Payment of dividend by the firm * Rising of fresh capital. With the help of arbitrage process, MM have shown that the dividend payment will not have any establish on the value of the firm. Even if the firm pays dividends, resulting in a increase in market value of the share, the effect on the value of the firm will be neutralised by the decrease in terminal value of the share.