Capital Structure theory : Modigiani miller theory (M & M )
Assumptions of M-M:
1.The companies do not pay value
2.Do not need to pay commission/fees to investment funds bankers /brokers on raise of capital
3.Do not cook to pay lawyers when company is declare bankrupt.
4.Perfect market
5. internal information of company is share by either
6. some(prenominal) firms and investors can borrow at the real(prenominal) interest measure.
·Modigliani- miller (M-M) proposition 1: The value of a firm is the same regardless of whether it finances itself with debt or legality. The weighted average monetary value of capital is constant.
Under MM assumptions ,firm identical in all aspects apart from capital structure should nonplus same value. note value is determined by stream of operating cash flows and the percentage point of business risk attaching to these , regardless of how cash flows are divided out between different classes of investor.
Under MM and excluding revenue enhancementes ,WACC perch the same- as gearing increases the impact of increasing cost of lawfulness ( Ke )is exactly offset by the lower cost of debt ( kd ) as shown in diagram .
Note from the diagram that a very high level of gearing MM believe that ke would surrender as equity risk taker come into the market permutation the existing shareholders who impart sale their part of shares due to sensing of increase of risk factor . Further extension of debt will increase cost of debt as lenders will increase rate of interest on debt due to increase in coat of debt .
This implies in calculation :
·Vg = Vug
·Keg= Keu + D/E ( Keu - kd )
·WACC g = WACC ug
Vg Value of geared entity
Vug Value of un-geared entity
Keg = Cost of equity geared
Keu = Cost of equity un-geared
Kd= Cost of debt
MM WITH TAXES :
In 1963 MM theory accepted that corporate taxation could have an impact as interest expense provide tax advantage . Therefore it was drawn that interest expense...If you want to modernize a full essay, order it on our website: Ordercustompaper.com
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