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Define the capital structure of a firm and relate to the Modigliani and Miller (M&M) theory...

Define the capital structure of a firm and relate to the Modigliani and Miller (M&M) theory of capital structure. Do you feel the M&M theory is correct in its findings on the capital structure of a firm? Why or why not?

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Expert Solution

Modigliani and Miller approach is always advocating that use of debt capital of equity capital will not be determining the value of the business because ultimately the value of a levered business and the unlevered business will be same, and when we will be taking the fact of the taxes than debt capital will be increasing the value of the overall business, so they will always be including a higher amount of debt capital into the overall capital structure of firm, as debt capital is tax deductible in nature.

No, I don't think that modigliani and Miller approach was correct in determination of capital structure because they were taking inappropriate assumptions like no transaction cost or tax free world but in actual there is a transaction cost and financial distress cost attached to the debt capital and Company can only take debt capital if they are in sound position to pay back, else it should lead to insolvency.

jeff jeffy answered 2 years ago
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