Equity

$100,000

$200,000

$200,000

required

Use the above example to illustrate the quantitative advantages to existing shareholders of a buy back arrangement.

Modigliani and Miller developed a theory describing a firm's optimal capital structure, ranging from a basic model assuming no corporate taxes, to an intermediate model including corporate taxes, and ultimately a model providing for costs of financial distress.

Describe in detail the optimal capital structure for a company in each of the following circumstances, and sketch appropriate diagrams where needeil:

i) No corporate tax ji)

Corporate tax

Corporate tax and costs of financial distress.