In: Finance
The Modigliani and Miller propositions says the following:
Suppose that there are no taxes or costs of financial distress Then,
Proposition I: The value of the firm is independent of the percentage of debt or equity in its capital structure.
Proposition II: The cost of equity capital is increasing in the percentage of debt in the capital structure.
rE = r0 + D E (r0 − rD)
where, r0 is the cost of capital if the firm were financed entirely with equity.
If there are no corporate or personal taxes, then ,
when corporate tax exists,