What are the assumptions of MM approach?
The Modigliani and Miller Approach further states that the market value of a firm is affected by its operating income, apart from the risk involved in the investment. The theory stated that the value of the firm is not dependent on the choice of capital structure or financing decisions of the firm.
Which of the following are equivalent under M&M proposition I?
Question: Which Of The Following Are Equivalent Under M&M Proposition I? Maximizing Firm Value And Maximizing Firm Profit Maximizing Firm Value And Minimizing The Cost Of Capital Minimizing Firm’s Cost Of Capital And Minimizing Firm’s Debt Burden Maximizing Profit And Minimizing Taxes.
What is MM approach of capital structure?
The Modigliani-Miller theorem states that a company’s capital structure is not a factor in its value. Market value is determined by the present value of future earnings, the theorem states. The theorem has been highly influential since it was introduced in the 1950s.
What is MM hypothesis?
The Modigliani and Miller approach to capital theory, devised in the 1950s, advocates the capital structure irrelevancy theory. This suggests that the valuation of a firm is irrelevant to the capital structure of a company.
What are the three capital structure cases?
Modigliani and Miller model describes three cases with different assumptions: Case I assumes no corporate or personal taxes and no bankruptcy costs, Case II adds corporate taxes and Case III includes corporate taxes (but no personal) and bankruptcy costs.
Why does MM Proposition I not hold in the presence of corporate taxes?
The reason that MM Proposition I does not hold in the presence of corporate taxation is because: Levered firms pay less taxes compared with identical unlevered firms. MM Proposition 1 with taxes is based on the concept that: The value of the firm increases as total debt increases because of the interest tax shield.
Which one of the following makes the capital structure of a firm irrelevant?
capital structure is irrelevant because investors and companies have differing tax rates.
Why the value of levered firm is always greater than the value of unlevered firm?
The value of levered firm is always greater than the value of unlevered firm because there is benefit of tax shield on Interest on Debt borrowing which cost less in compare to equity and It save Annual interest tax shield and which leads to increase in levered firm.
What is the optimal WACC?
The optimal capital structure is estimated by calculating the mix of debt and equity that minimizes the weighted average cost of capital (WACC) of a company while maximizing its market value. The lower the cost of capital, the greater the present value of the firm’s future cash flows, discounted by the WACC.
How does capital structure affect WACC?
Assuming that the cost of debt is not equal to the cost of equity capital, the WACC is altered by a change in capital structure. The cost of equity is typically higher than the cost of debt, so increasing equity financing usually increases WACC
Does an optimal capital structure exist?
The WACC, the total value of the company and shareholder wealth are constant and unaffected by gearing levels. No optimal capital structure exists.
What is the optimal capital structure quizlet?
What is optimal capital structure? a. It is the mix of debt, preferred stock and common equity that maximizes profits. It is the mix of debt, preferred stock and common equity that minimizes the weighted cost of the firm’s employed capital.
What is optimal capital structure?
The optimal capital structure of a company refers to the proportion in which it structures its equity and debt. It is designed to maintain the perfect balance between maximising the wealth and worth of the company and minimising its cost of capital. The WACC is the weighted average of its cost of equity and debt
What are the factors that influence optimal capital structure?
Capital Structure: 10 Factors Influencing Capital Structure –…
- Financial Leverage or Trading on Equity:
- Expected Cash Flows:
- Stability of Sales:
- Control over the Company:
- Flexibility of Financial Structure:
- Cost of Floating the Capital:
- Period of Financing:
- Market Conditions:
How is the optimal debt level is determined quizlet?
-To a point, the value of a firm increases as it uses more debt. -The optimal debt level occurs when the tax savings of additional debt are just offset by the increase in costs associated with a greater chance of bankruptcy.
What does a degree of financial leverage DFL of 2.0 indicate?
What does a degree of financial leverage (DFL) of 2.0 indicate? For every 1 percent change in its sales, the firm’s EBIT will change by 2 percent. For every 1 percent change in its EBIT, the firm’s EPS will change by 2 percent. For every 1 percent change in its EPS, the firm’s EBIT will change by 0.5 percent.
Why is debt often referred to as leverage?
Borrowing funds in order to expand or invest is referred to as “leverage” because the goal is to use the loan to generate more value than would otherwise be possible.
How does the level of debt affect the weighted average cost of capital?
The Weightings The “weighting” varies based on how the company finances its activities. If the value of a company’s debt exceeds the value of its equity, the cost of its debt will have more “weight” in calculating its total cost of capital than the cost of equity.
What happens when cost of capital increases?
When the demand for capital increases, the cost of capital also increases and vice versa. The demand is influenced greatly by the available market opportunities. If there are a lot of production opportunities in the market, more and more entrepreneurs will explore those opportunities to create profitable ventures.
What is WACC and why is it important?
The weighted average cost of capital (WACC) is an important financial precept that is widely used in financial circles to test whether a return on investment can exceed or meet an asset, project, or company’s cost of invested capital (equity + debt)
Is a higher WACC good or bad?
A high weighted average cost of capital, or WACC, is typically a signal of the higher risk associated with a firm’s operations. Investors tend to require an additional return to neutralize the additional risk. A company’s WACC can be used to estimate the expected costs for all of its financing
Why do we use WACC?
The purpose of WACC is to determine the cost of each part of the company’s capital structure. A firm’s capital structure based on the proportion of equity, debt, and preferred stock it has. Each component has a cost to the company. The company pays a fixed rate of interest.
What does negative WACC mean?
negative weighted average cost of capital
Is it possible to have a negative WACC?
WACC cannot be negative. WACC consists of cost of equity + after-tax cost of debt. Cost of equity is calculated based on CAPM – risk-free rate + market risk premium * beta of the company. This is a positive number.
Is WACC a percentage?
WACC is expressed as a percentage, like interest. So for example if a company works with a WACC of 12%, than this means that only (and all) investments should be made that give a return higher than the WACC of 12%. The easy part of WACC is the debt part of it.