Question
A firm has 120m to either invest in projects or pay out as dividends, and it currently has the following investment opportunities: 1) Project A:
A firm has 120m to either invest in projects or pay out as dividends, and it currently has the following investment opportunities: 1) Project A: 60m initial cost, 12m cash inflow in year 1 and growing at a constant rate of 5% for 6 additional years and then ceasing. 2) Project B: 70m initial cost, 10m cash inflow p.a. in first 6 years and then declining at a constant rate of 4% each year indefinitely. At the same point last year, the firm had 100m to either invest in projects or pay out as dividends, and it decided to pay out 20m in dividends. Investors expect this level of pay-out to be maintained.
Discus whether the assumptions made by Modigliani and Miller regarding the dividend irrelevancy theory reflect the real world.
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