M_M1 - Capital Structure Franco Modigliani and Merton...

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1 Capital Structure Franco Modigliani and Merton Miller ʻ Neither a borrower nor a lender be ʼ
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2 Relevant issues: Is there an “optimal” capital structure, i.e., an optimal combination of debt and equity? Can management create shareholder value by following a good financial policy? Does an optimal financial policy depend on the firm ! s operations that is, its real investment decisions?
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3 ! s " irrelevance theorem ! : Market efficiency: no asymmetric information No taxes No transaction or bankruptcy costs Under these assumptions, The value of the firm is independent of its capital structure
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4 Proof # 1: Take two firms L (levered) and U (unlevered) with identical streams of operating income. (Ignore Taxes!) M & M proposition I states: V L = V U Proof #1 Intuitively, going back to the additivity principle of cashflows in reverse, we can slice a cashflow into as many parts as desired; the value of the parts always sums back to the value of the unsliced stream.
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M_M1 - Capital Structure Franco Modigliani and Merton...

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