Q50983a ABC Ltd. belongs to a risk class for which the appropriate capitalization rate is 10%. It currently has outstanding 5,000 shares selling at Rs.100 each. The firm is contemplating the declaration of dividend of Rs.6 per share at the end of the current financial year. The company expects to have a net income of Rs.50, 000 and has a proposal for making new investments of Rs.l,00,000. Show that under the MM hypothesis, the payment of dividend does not affect the value of the firm.

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Solution:

  • Value of the firm when dividends are paid:

(a) Price of the share at the end of the current financial year

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  •  Value of the firm when dividends are not paid:

(b) Price per share at the end of the current financial year

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Hence, whether dividends are paid or not value of the remains same i.e Rs. 500,000.

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