The M&M theory 1 suggest that there is irrelevance in value of firm despite changes in capital structure. How is this so?

ref:Modigliani and Miller (M&M) studied capital structure theory regarding capital-structure irrelevance proposition.

Hypothesized that in perfect markets, it does not matter what capital structure a company uses to finance its operations.

The market value of a firm is determined by its earning power and by the risk of its underlying assets, and that its value is independent of the way it chooses to finance its investments or distribute dividends. (Source: Investopedia)

Explain clearly and comprehensively your understanding.

 

Q2 Explain how M&M theory has impact on the value of firm by providing relevant example of your own ref:Assumes benefits to leverage within a capital structure up until the optimal capital structure is reached. 

Recognizes the tax benefit from interest payments because interest paid on debt is tax deductible, issuing bonds effectively reduces a company's tax liability. 

Paying dividends on equity does not.Meaning the actual rate of interest companies pay on the bonds they issue is less than the nominal rate of interest because of the tax savings.

 

Q3 What have you learnt as a whole from M&M theory and their propositions. To what extent do you agree or disagree with their propositions?

Answer rating: 100% (QA)

1 MM theory 1 shows that in a perfect market a firms value is independent of its capital structure A companys market value is determined by its profit... View the full answer