Some of the dividend irrelevance theory investopedia forex different theories of dividend in financial management are as follows: 1. On the relationship between dividend and the value of the firm different theories have been advanced.
Walterargues that the choice of dividend policies almost always affects the value of the enterprise. All earnings are either distributed as dividend or reinvested internally immediately. Beginning earnings and dividends never change. E and D are assumed to remain constant forever in determining a given value. The firm has a very long or infinite life. The present value of the infinite stream of stream gains. Criticism: Walter’s model is quite useful to show the effects of dividend policy on an all equity firm under different assumptions about the rate of return.
However, the simplified nature of the model can lead to conclusions which are net true in general, though true for Walter’s model. Walter’s model of share valuation mixes dividend policy with investment policy of the firm. The model assumes that the investment opportunities of the firm are financed by retained earnings only and no external financing debt or equity is used for the purpose when such a situation exists either the firm’s investment or its dividend policy or both will be sub-optimum. The wealth of the owners will maximise only when this optimum investment in made. Walter’s model is based on the assumption that r is constant.
In fact decreases as more investment occurs. This reflects the assumption that the most profitable investments are made first and then the poorer investments are made. This is clearly an erroneous policy and fall to optimise the wealth of the owners. Thus, the present value of the firm’s income moves inversely with the cost of capital. By assuming that the discount rate, K is constant, Walter’s model abstracts from the effect of risk on the value of the firm. The corporate taxes do not exist. They argue that the value of the firm depends on the firm’s earnings which result from its investment policy.
Thus, when investment decision of the firm is given, dividend decision the split of earnings between dividends and retained earnings is of no significance in determining the value of the firm. M’s hypothesis of irrelevance is based on the following assumptions. Risk of uncertainty does not exist. That is, investors are able to forecast future prices and dividends with certainty and one discount rate is appropriate for all securities and all time periods.