A Firm 's Total Market Value

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The results obtained from the cooperation of Modigliani and Miller in 1958, was an attempt to prove that the financial decisions should not be significant in the perfect conditions of the market, after being published the Modigliani and Miller theory became the main theory of the capital structure. In the M&M theory it suggested that the market is fully efficient, meaning that there are no taxes, however in the theory Modigliani and Miller included the taxes to be able to reflect their theories in reality, and the theory also suggested that there are no bankruptcy costs. There are three propositions that were published by Modigliani and Miller which are: • Proposition 1: A firm’s total market value is independent of its capital structure.…show more content…
Modigliani & Miller applied their theories with two modules, one which doesn’t include the taxes and this is their first findings, and another one with taxes to make it more realistic. The First Proposition without taxes: In this part Modigliani & Miller stated that the firm’s value is not affected by the structure of the capital between Equity and Debt, They proved this by having an example of two firms that has got the same conditions in everything, same cash flow, same operational risks and same opportunity costs. One of the firm’s capital structure is all equity and the other firm’s capital structure is a mixture between equity and debt, since the form of financing (debt or equity) can neither change the firm’s net operating income nor its operating risk, the values of levered and unlevered firms will be the same. They have concluded that the value of the levered firm = the value of the unlevered firm, only if they have the same conditions, same risk levels, cash and opportunity cost. This approach were formed without applying the taxes, but with including the taxes it should be as the following: The First Proposition with taxes: In this section Modigliani and Miller applied the first proposition approach with taxes, findings to this is that the capital structure directly impact the firm’s market value, this is because M&M found
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