Question

Indicate whether you agree with the following statement that describes Modigliani and Miller's work:

"In the absence of taxes, bankruptcy costs and asymmetric information, and in an efficient market, the value of the firm is unaffected by how that firm is financed" (MIT Sloan Lecture Notes, Finance Theory II, Dirk Jenter, 2003).

Answer 1

This statement is related to irrelevance proposition theorem which advocates that value of firm is completely unaffected by how the firm is financed.

This is a theorem which has been advocated by Modigliani and Miller in tax free world which is having no taxes and there is no cost of financial distress including bankruptcy cost and there are no asymmetric information so all the market participants will be having equal knowledge about various events and there will be no information discrepancies so it will be an Efficient market where the value of the company is completely unaffected by how the company is financed and hence this is a preposition which has been advocated by Modigliani and Miller.

I do not agree with this statement because the current world is full of taxation and presence of financial distress cost along with presence of information discrepancy and Markets are not efficient in nature so this proposition is a highly theoretical proposition and this has no relevance in the real life and hence I completely disagree.