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M M Approach

The M.M. model posits that dividend policy is irrelevant to a firm's share price and overall value, which are determined by earnings and investment policy. It operates under several assumptions, including no corporate tax and a perfect capital market, leading to the conclusion that a firm's market value remains unaffected by its dividend decisions. The document also includes formulas for calculating share price and firm value, along with examples demonstrating the model's implications in different scenarios.

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676 views3 pages

M M Approach

The M.M. model posits that dividend policy is irrelevant to a firm's share price and overall value, which are determined by earnings and investment policy. It operates under several assumptions, including no corporate tax and a perfect capital market, leading to the conclusion that a firm's market value remains unaffected by its dividend decisions. The document also includes formulas for calculating share price and firm value, along with examples demonstrating the model's implications in different scenarios.

Uploaded by

gowdanishu729
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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M.M.

model (Modiglinani and Miller)

According to M.M. model, dividend policy is irrelevant and its is


doesn’t affect the share price and value of the firm. M.M. agrees that,
the value of the firm depends on from earnings and which results from
investment policy. According to m. M. Model, it is not important in
determining the share price, and value of the firm

Assumptions.
1. M.M. Theory or irrelevant Theory, there is no corporate Tax.
2. The firm has a fixed investment policy.
3. Investors are able to forecast future Share price and amount
dividend.
4. The firm operates a perfect capital market
when the above assumptions are satisfied, the market value of the
firm remains unaffected by the dividend policy of a company. In other
words, the of each company is freely chosen management of chosen
its own dividend policy.

Formulas by using M.M Model


→ Calculation of market price of the share at beginning
D1 + P1
Po =
1+K
Whereas,
Po= share price at the beginning
P1= share price at the end
D1= dividend declared at end of the period
K = cost of capital
→ Calculation of market value of the firm

(N + M)P1 − (I − E)
NPo =
K
Whereas,
NPo= value of the firm
N= numbers of shares outstanding
M = number of shares to be issued in the current year
I= current year investment
E= current year earnings
K = cost of capital
Note:-
• If P1 is not given P1 = Po(1+K)-D1
• If M is not given
𝐼−(𝐸−𝑁𝐷1)
M=
𝑃1

Problems on Miller-Modigliani (M M) Hypothesis


1. ABC co. ltd belongs to risk class, for which the appropriate capitalisation
rate is 10%. It currently has 5000 shares outstanding selling at Rs. 100
each. The firm is thinking of deceleration of dividend is Rs. 6 per share at
the end of the current year. The company expected to have a net income of
Rs. 50,000. And as a proposal making new investment of Rs. 1,00,000.
Show that under M.M. the value of the firm is not effected under the
following situation
a) When dividends are paid
b) When no dividends are paid
2. XYZ company ltd has 10,000 shares outstanding at a market price of Rs.
100 each the company has taken decision to declare dividend of Rs. 8 per
share at the end of financial year and the overall capitalisation rate is
10%. The company is expected to have net earnings of Rs. 1,20,000 and
has proposal for making a new investment of Rs. 2,50,000. Show that the
companies’ effect under the following situations:
a) When dividends are paid
b) When no dividends are paid

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