An Illustration of the Irrelevance of Dividend Policy

A powerful argument can be made that dividend policy does not matter. We illustrate this by considering the simple case of Wharton Corporation. Wharton is an all-equity firm that has existed for 10 years. The current financial managers plan to dissolve the firm in two years. The total cash flows the firm will generate, including the proceeds from liquidation, will be $10,000 in each of the next two years.

Current Policy: Dividends Set Equal to Cash Flow At the present time, dividends at each date are set equal to the cash flow of $10,000. There are 100 shares outstanding, so the dividend per share is $100. In Chapter 6, we showed that the value of the stock is equal to the present value of the future dividends. Assuming a 10 percent required return, the value of a share of stock today, P0, is:

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VI. Cost of Capital and Long-Term Financial Policy

18. Dividends and Dividend Policy

© The McGraw-Hill Companies, 2002

PART SIX Cost of Capital and Long-Term Financial Policy

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