Economic Paper

Topics: Investment, Corporate finance, Finance Pages: 30 (8751 words) Published: June 1, 2013
American Economic Association

The Cost of Capital, Corporation Finance and the Theory of Investment Author(s): Franco Modigliani and Merton H. Miller Source: The American Economic Review, Vol. 48, No. 3 (Jun., 1958), pp. 261-297 Published by: American Economic Association Stable URL: Accessed: 10/09/2009 09:51 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit organization founded in 1995 to build trusted digital archives for scholarship. We work with the scholarly community to preserve their work and the materials they rely upon, and to build a common research platform that promotes the discovery and use of these resources. For more information about JSTOR, please contact

American Economic Association is collaborating with JSTOR to digitize, preserve and extend access to The American Economic Review.



JUNE 1958




What is the "cost of capital" to a firm in a world in which funds are used to acquire assets whose yields are uncertain; and in which capital can be obtained by many different media, ranging from pure debt instruments, representing money-fixed claims, to pure equity issues, giving holders only the right to a pro-rata share in the uncertain venture.? This question has vexed at least three classes of economists: (1) the corporation finance specialist concerned with the techniques of financing firms so as to ensure their survival and growth; (2) the managerial economist concerned with capital budgeting; and (3) the economic theorist concerned with explaining investment behavior at both the micro and macro levels.'

In much of his formal analysis, the economic theorist at least has tended to side-step the essence of this cost-of-capital problem by proceeding as though physical assets-like bonds-could be regarded as yielding known, sure streams. Given this assumption, the theorist has concluded that the cost of capital to the owners of a firm is simply the rate of interest on bonds; and has derived the familiar proposition that the firm, acting rationally, will tend to push investmnent to the point * The authors are, respectively, professor and associate professor of economics in the Graduate School of Industrial Administration, Carnegie Institute of Technology. This article is a revised version of a paper delivered at the annual meeting of the Econometric Society, December 1956. The authors express thanks for the comments and suggestions made at that time by the discussants of the paper, Evsey Domar, Robert Eisner and John Lintner, and subsequently by J'ames Duesenberry. They are also greatly indebted to many of their present and former colleagues and students at Carnegie Tech who served so often and with such remarkable patience as a critical forum for the ideas here presented. 1 The literature bearing on the cost-of-capital problem is far too extensive for listing here. Numerous references to it will be found throughout the paper though we make no claim to completeness. One phase of the problem which we do not...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • CP Paper case
  • School Papers
  • Naked Economics Essay
  • Enzymes and Paper
  • General Paper
  • Banana Paper
  • Paper Flower
  • Ancient Paper

Become a StudyMode Member

Sign Up - It's Free