What is meant by the following equation: VU(MM’58) > VU(MM’63) > VU(Miller’77)

Solutions

Expert Solution

VU stands for value of unlevered firm
Parenthesis indicates the capital strucutre model/theory and the corresponding year

In 1958, Modigliani Miller came out with proposition in absence of taxes, transaction costs etc. which said unlevered firm value is same as levered firm value.

In 1963, Modigliani Miller came out with proposition in presence of taxes, transaction costs etc. which said unlevered firm value is lesser than levered firm value by the tax shields of debt.

In 1977, Miller came out with proposition considering both corporate and personal taxes which said the benefit of debt increases in corporate tax rate (higher tax shield), increases in personal tax rate on income from stocks (equity is more expensive), and decreases in personal tax rate on income from bonds (debt is more expensive). Thus, value of levered firm is more than the value arrived at in 1963. Hence, value of unlevered firm is also less than the value arrived at in 1963.

Therefore,
VU(MM’58) > VU(MM’63) > VU(Miller’77)

jeff jeffy answered 1 year ago

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