CORPORATE FINANCE MINICASE - Essay Example

Explain what these terms mean, and briefly describe each theory. Dividend irrelevance theory refers to a theory where there is a difference between the dividends, capital gains and making of dividend policy irrelevant and which do not have an effect on the value of the firm. This theory was developed and proposed by MM however there have been a number of assumptions that have been made to prove that it is zero. In the theory MM had argues that paying out a dollar on a share would lead to reduction of the growth of earnings, dividends as the stock require to be sold to be able to make up for the capital paid in terms of dividends.

The ‘bird – in - the – hand’ refers a theory where the dollar of dividends in hand is a preferred solution rather than a dollar that is retained in the business. In these cases as well the dividend policy has not effect on the firm’s value. This theory on the other hand was identified and recognised by Myron Gordon and Jon Lintner. The major argument was that the investors note a dollar of dividend to be much less riskier when in hand rather than in the retained earnings of a company.

In this case the investors will regard the firm with a high payout ratio than being a less risky with a low payout ratio. The two theories oppose one another as the MM stated that the Gordon Lintner spoke of the firm’s risk to be dependent on the riskiness of its cash flows from the assets and the capital structure. However it is not how its earnings are distributed among the investors. It is essential to understand that if the dividend irrelevance theory is accurate, then it would mean that there are no consequences of the dividend payout theory.

In case the bird – in – the – hand theory is correct, then the firms would have a high payout if it maximised its stock prices. If the tax preference theory is accurate, it will be noted that the firm