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sir i dont understand dividend irrelevance theory,
i mean, the dividend valuation model that we use to calculate ex market price seems to suggest that dividend affects share price?The dividend irrelevance theory, also known as Modigliani-Miller theorem, states that the dividend policy of a company has no impact on its share price. According to this theory, shareholders are indifferent between receiving dividends and capital gains.
The dividend valuation model, which is used to calculate the ex-market price, may suggest that dividends affect share price, but this is not the case according to the dividend irrelevance theory.
The model assumes that the market is perfect and that investors can reinvest dividends at the same rate of return as the company. In reality, however, various factors such as market imperfections, investor preferences, and signaling effects can influence the relationship between dividends and share price.
also i had just one other query
do the dividend irrelevance theory assume that reinvestment must not lead to negative npv?The dividend irrelevance theory does not assume that reinvestment must not lead to negative NPV.
The theory argues that shareholders are indifferent between receiving dividends or capital growth and that the level of dividends is irrelevant.
It suggests that if a dividend is cut now, the extra retained earnings reinvested will allow future earnings and future dividends to grow.Sir in Kaplan study text why it states that
“Provided positive npv project are invested in, the shareholder will be indifferent between dividend and capital growth.”
Why specifically POSITIVE NPV ?
So what will happen if negative npv project occurs?Can you tell me why you want to know and question what Kaplan have written in their textbook. So a positive NPV indicates that the returns from the investments will be higher than the return required by investors, leading to higher dividends in the future. Shareholders are willing to forgo immediate dividends in favour of capital growth if it means higher future dividends.
Specifically focusing on positive NPV projects is important because it signifies that the project is expected to generate a higher return than the cost of capital. This means that the project is adding value to the company and increasing shareholder wealth. By investing in positive NPV projects, the company can maximise shareholder wealth and provide a higher return to shareholders in the long run.
If a negative NPV project occurs, it means that the project is expected to generate a lower return than the cost of capital.
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