Capital Structure & MM Theory Flashcards
(3 cards)
What is capital structure?
What is the main question of capital structure theory?
Capital structure is how a firm finances itself — the mix of debt and equity it uses.
Example: A firm might be 60% equity, 40% debt.
Does the mix of debt and equity affect the company’s total value or cost of capital?
What does MM Proposition I say?
Modigliani & Miller (with tax^
What does MM Proposition II say?
In a world with no taxes, bankruptcy costs, or imperfections: Capital structure is irrelevant — the firm’s value depends only on its assets and profits .
interest on debt is tax-deductible — this creates a tax shield, which adds value to the firm.
• So, using some debt can lower the firm’s overall cost of capital (WACC) and increase value.
What changes when corporate tax is introduced (MM with taxes)?
