Modigliani and Merton Miller basics assumptions
under a questionable set of assumptions, that a firm’s value should be unaffected by its capital structure
no brokerage costs,
no taxes,
no bankruptcy costs, Investors can borrow at the same rate as corporations,
all investors have the same information as management about the firm’s future investment opportunities
EBIT is not affected by the use of debt
Why are Modigliani and Merton Miller important?
By indicating the conditions under which capital structure is irrelevant, MM provided us with clues about what is required if capital structure is to be relevant.
Defintion of Assets in place
Existing assets generate cashflow today
long lived fix capital
short lived working capital
Definition of Growth Assets
Expected value that will be generated by future investments
Defintion of Debt
Fixed claim on cash flows
little or no role in managment
fixed maturity
tax deductible
Definition of Equity
residual claim on cash flows
significant role in management
perpetual lives
Does taxes are good or bad in the world of companies?
Generally, interest on debt are deductable and therefore has a strong effect
tax systems favor the use of debt
What is Mod. and Miller saying about bankruptcy?
high legal and accounting expanses
hard time retaining personal, costumers and suppliers
force to liquidate assets
the fear of bankruptcy costs discourage firms from pushing their use of debt excessive levels
main threats are: probability of bankruptcy and the costs of it
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