CFA Level 1: MM Hypothesis and Dividend Policy

MM Hypothesis and Dividend Policy

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Question

If the MM hypothesis about dividends is correct, and if one found a group of companies which differed only with respect to dividend policy, which of the following statements would be most correct?

Answers

A. All of these statements are true.

B. The residual dividend model should not be used, because it is inconsistent with the MM dividend hypothesis.

C. The total expected return, which in equilibrium is also equal to the required return, would be higher for those companies with lower payout ratios because of the greater risk associated with capital gains versus dividends.

D. None of these statements are true.

E. If the expected total return of each of the sample companies were divided into a dividend yield and a growth rate, and then a scatter diagram (or regression) analysis were undertaken, then the slope of the regression line (or b in the equation D1/Po = a + b(g)) would be equal to +1.0.

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Explanations

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A. B. C. D. E.

None of these statements are correct. Miller and Modigliani argued that the value of the firm depends only on the income produced by its assets, not on how this income is divided between dividends and retained earnings.

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