7 - Equity sources and dividend policy

Question 1

Dividend policy - traditional view

Answer 1

• constant dividend stream is important, cutting dividend may reduce shareholder wealth
• shareholders may prefer the certainty of a cash dividend now to higher dividends in the future

Question 2

M&M’s dividend irrelevance hypothesis

Answer 2

• pattern of dividends does not affect shareholder wealth
• focusing on investing in all projects with NPV >0 will lead to increased dividend in the future that will more than compensate for the cut today
• shareholders can ‘manufacture dividends’ by selling shares if needs be

Question 3

Assumptions of M&M dividend theory

Answer 3

• perfect information (no signalling)

- investors indifferent between income and capital growth