The Theory Proposed By Modigliani And Miller

3648 Words Aug 25th, 2014 15 Pages
Literature review
The theory proposed by Modigliani and Miller is also identical to operating income theory in the original proposition they proposed that in the absence of taxes, cost of capital and business value of the firm will not be affected by the capital structure changes.
The model introduced by Modigliani and Miller in their paper in 1958 has been come up as a challenged to all economists, scholars and researchers. But they have been struggling to answer the question pose by M&M model about tax benefit of leverage, by the time gone researchers gave many theories but they have not agreed upon one satisfactory result. So the purpose of the study will be to explain the main theories that contribute to the literature of capital structure and also determine what each theory predicts and also to compare the empirical evidence from all around the world. The main proposal of MM’s model was that under certain conditions the value of the firm is independent of its capital structure. Their argument was that firm investment policy affects the value of the firm, whereas the financing decision is secondary. The model was based on assumptions that the firm’s managers are selfless and they work in the interest of the investor, the debt is risk free and they also ignored the effects of corporate taxes. In capital structure the cost and benefits of leverage motivate managers to decide the leverage in it. The question is do the firms have any target leverage that changes overtime…
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