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MODIGLIANI AND MILLER’S ADVICE ON DEBTS IGNORED BY COMPANIES
Finance & Accounting
Pages 7 (1757 words)
Modigliani and miller’s advice on debts ignored by companies Professor: University: The theorem by Modigliani and Miller, the Nobel Prize-winning organization regarding capital has drawn numerous reactions from various parties. Modigliani and Miller stated that the structure of an organization’s or company’s capital does not matter1.
Considering the setting of a perfect market, with the absence of frictions, a seminal research conducted by Modigliani and Miller in 1958 proposed that the value of an organization’s market tends to operate in independence of such an organization’s capital structure. The argument by Modigliani and Miller had the essence, adding on the value of debt tends to lower the value of any outstanding capital (equity). Firm’s gain realized by utilizing more of the so seemed cheaper debt will be offset through the implementation of a higher costing policy of the adopted riskier equity. Therefore, considering a fixed value of total equity, the capital allocation between equity and debt will thus be irrelevant since the two capital costs’ weighted average will be of the same amount regardless of any possible combination of the two capital costs2. Unfortunately, no corporation operates in a perfect business world; few if any, are debt financed 100%. ...
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