At time 0 your company has 100 of cash on its bank account and it might immediately distribute it as a dividend, which would drive its cash balance down to zero. The company has no debt. At time 1 two equally likely alternative scenarios might occur: Scenario 1 There is no positive NPV investment, and the value of the assets in place will depend on the state of the world at time 2: Pr(State 1)=1 Pr(State 2) Assets in Place 150 250 NPV new investment 0 0 Scenario 2 There is a positive NPV (risky) investment costing 100. Both the NPV of the risky investment and the value of the assets in place will depend on the state of the world at time 2: Pr(State 1)= Pr(State 2)=2 Assets in Place 150 250 NPV new investment 20 10 In case at time 1 the company has a 0 cash balance, it can only raise the funds for the new investment by issuing new equity. The management of the company works in the interest of existing (current) shareholders, and it already knows the state of the world (that will be realized at time 2) at time 1. All other agents will only know the state of the world at time 2. Finally assume that all agents are risk neutral and that the interest rate is equal to zero. If the company distributes the 100 in cash as dividend at time 0 By how much would the company's equity value change at time 0 following the dividend payment? Does the Modigliani Miller dividend policy irrelevance argument hold true in this case? Why? At time 0 your company has 100 of cash on its bank account and it might immediately distribute it as a dividend, which would drive its cash balance down to zero. The company has no debt. At time 1 two equally likely alternative scenarios might occur: Scenario 1 There is no positive NPV investment, and the value of the assets in place will depend on the state of the world at time 2: Pr(State 1)=1 Pr(State 2) Assets in Place 150 250 NPV new investment 0 0 Scenario 2 There is a positive NPV (risky) investment costing 100. Both the NPV of the risky investment and the value of the assets in place will depend on the state of the world at time 2: Pr(State 1)= Pr(State 2)=2 Assets in Place 150 250 NPV new investment 20 10 In case at time 1 the company has a 0 cash balance, it can only raise the funds for the new investment by issuing new equity. The management of the company works in the interest of existing (current) shareholders, and it already knows the state of the world (that will be realized at time 2) at time 1. All other agents will only know the state of the world at time 2. Finally assume that all agents are risk neutral and that the interest rate is equal to zero. If the company distributes the 100 in cash as dividend at time 0 By how much would the company's equity value change at time 0 following the dividend payment? Does the Modigliani Miller dividend policy irrelevance argument hold true in this case? Why
