Modigliani and Miller (MM) Argued That Dividend Policy Is Irrelevant

question 7

Multiple Choice

Modigliani and Miller (MM) argued that dividend policy is irrelevant. On the other hand, Gordon and Lintner (GL) argued that dividend policy does matter. GL's argument rests on the contention that

• A) rs = D1/P0 + g is constant for any dividend policy.
• B) Because of perceived differences in risk, investors value a dollar of dividends more highly than a dollar of expected capital gains.
• C) Investors, because of tax differentials, value a dollar of expected capital gains more highly than a dollar of dividends.
• D) Most investors will reinvest rather than spend dividends, so it would save investors money (taxes) if corporations simply reinvested earnings rather than paid them out as dividends.
• E) None of the answers above.

---

Definitions:

Realized Rate

The actual return earned on an investment over a specific period, including interest, dividends, and capital gains.

Investment Horizon

Investment horizon refers to the total length of time that an investor expects to hold a security or a portfolio.

Promised Yield

The return that a bond issuer indicates to the bondholder that will be received, factoring in the interest rate and the term.

Cash Flow Matching

A strategy of investing in such a way that cash flows from the investments will meet the investor's outflows when needed, often used in pension planning and managing corporate finances.