What does the Modigliani-Miller theorem say?
The Modigliani-Miller theorem states that a company’s capital structure is not a factor in its value. Market value is determined by the present value of future earnings, the theorem states. The theorem has been highly influential since it was introduced in the 1950s.
What is M & M Proposition 1?
The first proposition states that tax shields that result from the tax-deductible interest payments make the value of a levered company higher than the value of an unlevered company. The main rationale behind the theorem is that tax-deductible interest payments positively affect a company’s cash flows.
What is MM Proposition I and II without taxes?
MM Proposition I (without taxes): The market value of the company is not affected by the capital structure of the company. VL = VU. MM Proposition II (without taxes): The cost of equity is a linear function of the company’s debt/equity ratio.
What are assumptions of MM theory of capital structure?
The Modigliani-Miller theorem argues that it does not matter how the firm is financed. In the end, the profitability and viability of the firm is unaffected by its financing decisions.
What are Modigliani and Miller theories of capital structure?
Modigliani and Miller Theories. Modigliani and Miller theories of capital structure (also called MM or M&M theories) say that (a) when there are no taxes, (i) a company’s value is not affected by its capital structure and (ii) its cost of equity increases linearly as a function of its debt to equity ratio but when (b) there are taxes,…
What is the Modigliani-Miller theorem and how does it work?
What is the Modigliani–Miller Theorem? The theory suggests that a company’s capital structure and the average cost of capital does not have an impact on its overall value. The company’s value is impacted by its operating income or by the present value of the company’s future earnings.
How does the Modigliani and Miller propositions work?
the equation reduces to MM Proposition II without taxes. In the following interactive app you can change the tax rate, and costs of unlevered equity and debt, and see the cost of levered equity, debt, and WACC as a function of the debt-to-equity ratio. Note that the benefit of debt on the WACC is increasing in the tax rate.
Who are the professors of Modigliani and Miller?
During this time, both Modigliani and Miller were professors at the Graduate School of Industrial Administration (GSIA) at Carnegie Mellon University. Both were set to teach corporate finance to business students, though, neither had any experience in corporate finance.
