## Advantages & Limitations of the Dividend Theories
For theory questions, the examiner often asks only for the merits and demerits of each dividend model. Learn these crisply.
### MM (Modigliani–Miller) Hypothesis — dividend irrelevance
Advantages
1. The model is logically consistent.
2. It provides a satisfactory framework on dividend policy through the concept of the Arbitrage process.
Limitations
1. The validity of its various assumptions is questionable.
2. The model may not hold under uncertainty.
### Walter's Model
Advantages
1. The formula is simple to understand and easy to compute.
2. It can envisage different market prices in different situations, considering the internal rate of return (r), the market capitalisation rate (Kₑ) and the dividend payout ratio in valuing shares.
Limitations
1. It does not consider all factors affecting dividend policy and share prices; determining the market capitalisation rate is difficult.
2. It ignores taxation, legal & contractual obligations, and management's attitude toward dividend policy.
### Gordon's Model (Dividend Discount Model)
Advantages
1. A useful heuristic model relating the present stock price to the present value of future cash flows.
2. Easy to understand.
Limitations
1. Depends on projections of growth rate and future capitalization rates, which are hard to calculate accurately.
2. The true intrinsic value of a stock is difficult to determine realistically.
> Memory hook: All three share a common weakness — they rest on assumptions that break down under uncertainty and real-world frictions (tax, legal, growth estimates).