fm17 22 - e. What capital structure policy recommendations...

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Mini Case: 17 - 22 e. What capital structure policy recommendations do the three theories (MM without taxes, MM with corporate taxes, and Miller) suggest to financial managers? Empirically, do firms appear to follow any one of these guidelines? Answer: In a zero tax world, MM theory says that capital structure is irrelevant--it has no impact on firm value. Thus, one capital structure is as good as another. With corporate but not personal taxes considered, the MM model states that firm value increases continuously with financial leverage, and hence firms should use (almost) 100 percent debt financing. Miller added personal taxes to the analysis, and the value of debt financing is seen to be reduced but not eliminated, so again firms should use (almost) 100 percent debt financing. The Miller model is the most realistic of the three, but if it were really correct, we would expect to see firms using almost all debt financing. However, on average, firms use only about 40 percent debt. Note, though, that debt ratios increased all
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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