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Modigliani Millar Approach Homework Help, Tutoring
Home > Finance > Capital Structure Theories > Modigliani Millar Approach
Limitations of MM Hypothesis Assignment Help, Tutor Help
Modigliani Millar Approach
Modigliani Millar approach, popularly known as the MM approach is similar to the Net operating income approach. The MM approach favors the Net operating income approach and agrees with the fact that the cost of capital is independent of the degree of leverage and at any mix of debt-equity proportions. The significance of this MM approach is that it provides operational or behavioral justification for constant cost of capital at any degree of leverage. Whereas, the net operating income approach does not provide operational justification for independence of the company's cost of capital.
Basic Propositions of MM approach:
At any degree of leverage, the company's overall cost of capital (ko) and the Value of the firm (V) remains constant. This means that it is independent of the capital structure. The total value can be obtained by capitalizing the operating earnings stream that is expected in future, discounted at an appropriate discount rate suitable for the risk undertaken.
The cost of capital (ke) equals the capitalization rate of a pure equity stream and a premium for financial risk. This is equal to the difference between the pure equity capitalization rate and ki times the debt-equity ratio.
The minimum cut-off rate for the purpose of capital investments is fully independent of the way in which a project is financed.
Assumptions of MM approach:
Capital markets are perfect.
All investors have the same expectation of the company's net operating income for the purpose of evaluating the value of the firm.
Within similar operating environments,
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Modigliani Millar Approach Homework Help, Tutoring
Home > Finance > Capital Structure Theories > Modigliani Millar Approach
Limitations of MM Hypothesis Assignment Help, Tutor Help
Modigliani Millar Approach
Modigliani Millar approach, popularly known as the MM approach is similar to the Net operating income approach. The MM approach favors the Net operating income approach and agrees with the fact that the cost of capital is independent of the degree of leverage and at any mix of debt-equity proportions. The significance of this MM approach is that it provides operational or behavioral justification for constant cost of capital at any degree of leverage. Whereas, the net operating income approach does not provide operational justification for independence of the company's cost of capital.
Basic Propositions of MM approach:
At any degree of leverage, the company's overall cost of capital (ko) and the Value of the firm (V) remains constant. This means that it is independent of the capital structure. The total value can be obtained by capitalizing the operating earnings stream that is expected in future, discounted at an appropriate discount rate suitable for the risk undertaken.
The cost of capital (ke) equals the capitalization rate of a pure equity stream and a premium for financial risk. This is equal to the difference between the pure equity capitalization rate and ki times the debt-equity ratio.
The minimum cut-off rate for the purpose of capital investments is fully independent of the way in which a project is financed.
Assumptions of MM approach:
Capital markets are perfect.
All investors have the same expectation of the company's net operating income for the purpose of evaluating the value of the firm.
Within similar operating environments,