Nielson Motors (NM) has no debt. Its assets will be worth $600 million in one year if the economy is strong, but only $300 million if the economy is weak. Both events are equally likely. The market value today of Nielson's assets is $400 million.Suppose the risk-free interest rate is 4%. If Nielson borrows $150 million today at this rate and uses the proceeds to pay an immediate cash dividend, then according to MM, the market value of its equity just after the dividend is paid would be closest to:Group of answer choices$250 million.$0 million.$400 million.$150 million.
Question
Nielson Motors (NM) has no debt. Its assets will be worth 300 million if the economy is weak. Both events are equally likely. The market value today of Nielson's assets is 150 million today at this rate and uses the proceeds to pay an immediate cash dividend, then according to MM, the market value of its equity just after the dividend is paid would be closest to:Group of answer choices0 million.150 million.
Solution
The Modigliani-Miller theorem (MM) states that the market value of a company is calculated based on its earning power and the risk of its underlying assets and is independent of the way it finances investments or distributes dividends.
Given that the market value of Nielson's assets today is 150 million to pay an immediate cash dividend, the market value of the company's equity just after the dividend is paid would be the market value of the assets minus the borrowed amount.
So, 150 million (borrowed amount) = $250 million.
Therefore, according to MM, the market value of Nielson's equity just after the dividend is paid would be closest to $250 million.
Similar Questions
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