Question

Modiglinani & Miller Theory

What is your opinion about the M & M theory?

Answer 1

ANSWER DOWN BELOW. FEEL FREE TO ASK ANY DOUBTS. THUMBS UP PLEASE.

Opinion on the MM World:

a. Under the MM approach:

MM Approach is used to evaluate the overall cost of capital of the firm. Which is the required rate of return of the company for its capital budgeting decisions.

Its gives the weighted average cost of capital as:

WACC = weight of equity x cost of equity+ weight of debt X cost of debt.

The value of the firm is dependent upon its capital structure.

b. Under the MM approach in a world with perfect capital markets, there is an assumption that there are no taxes, no transaction cost.

In such a world:

The value of the company will remain the same.

This is only a change in the capital structure of the company.

The amount of debt issued will be used today repurchase stocks, Thus reducing equity.

(As there are no taxes, there is no tax benefit for the issue of debt).

The overall weighted average cost of capital of the company will always be equal to the unlevered cost of equity.

Thus WACC remains constant.

There is only a change in the cost of equity- it is based upon the capital structure of the company.

c. As per MM Approach with no taxes.

The firms capital structure doesn't change the overall weighted average cost of capital.

That is the weighted average cost of capital will remain constant.

However, The levered equity cost of capital will change in proportion to debt to equity ratio.