Question #32
Reading: Reading 15 Analysis of Dividends and Share Repurchases
PDF File: Reading 15 Analysis of Dividends and Share Repurchases.pdf
Page: 12
Status: Unattempted
Correct Answer: A
Question
According to Modigliani and Miller's dividend irrelevancy theory, an investor in a firm that does not pay a dividend can still earn a "dividend" on that company by:
Answer Choices:
A. selling a portion of the company's stock each year
B. slowly liquidating the fixed income portion of the investor’s portfolio
C. writing covered call options on the underlying stock
Explanation
Miller and Modigliani's dividend irrelevancy theory states that shareholders can create
their own dividend policy. If a firm does not pay dividends, a shareholder who wants a 4%
dividend can "create" it by selling 4% of his or her stock. Note that Modigliani and Miller's
theory assumes zero transaction costs or taxes. In actual practice, shareholders will have
to pay transaction costs, and tax on any capital gains.