This document discusses the Modigliani-Miller capital structure theory, which states that a firm's value and cost of capital are independent of its capital structure under certain assumptions. It provides examples to illustrate the theory, showing that the overall cost of capital remains constant regardless of the debt-to-equity ratio. The document also notes that according to MM, while the cost of debt is lower than the cost of equity, the cost of equity increases in a way that offsets the benefits of using debt.
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It suggests that the firm value is maximum with right proportion of debt and equity mix
As per this approach, debt funding should exist in the capital structure only up to a certain level, after which, any increase in debt funding would result in the reduction in value of the firm by increasing cost of equity
It advocates that there exists an optimum level of debt and equity at which the WACC is the lowest and the market value of the firm is the highest
Assumptions
There are only two sources of financing – Debt and Equity
The interest rate on debt remains constant to a certain level after which it increases with an increase in debt financing
The expected rate of return on equity increases gradually to a certain level after which it increases speedily with increase in debt because of the financial risk involved
WACC first decreases and then starts increasing with increased interest rate on debt and increased required rate of return on equity
No taxes & transaction cost
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Financial accounting & analysis nmims latest solved assignmentssmumbahelp
Dear students get fully solved assignments
Send your semester & Specialization name to our mail id :
help.mbaassignments@gmail.com
or
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Watch out full video on Youtube -
https://youtu.be/VP2ZqqWmUvM
It suggests that the firm value is maximum with right proportion of debt and equity mix
As per this approach, debt funding should exist in the capital structure only up to a certain level, after which, any increase in debt funding would result in the reduction in value of the firm by increasing cost of equity
It advocates that there exists an optimum level of debt and equity at which the WACC is the lowest and the market value of the firm is the highest
Assumptions
There are only two sources of financing – Debt and Equity
The interest rate on debt remains constant to a certain level after which it increases with an increase in debt financing
The expected rate of return on equity increases gradually to a certain level after which it increases speedily with increase in debt because of the financial risk involved
WACC first decreases and then starts increasing with increased interest rate on debt and increased required rate of return on equity
No taxes & transaction cost
Thank you for Watching
Subscribe to DevTech Finance
Financial Management
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Effect of operating, financial and total leverage on expected stock return an...Shoaib Lalani
Regardless of the size and nature, largely all businesses are dependent on leverage. This research called for analyzing the impact of leverage on equity elements like the earnings to price ratio, Market value of equity and book to market ratio. Later on we also tested to identify the relationship between leverage and on expected stock returns. Financial data for different companies ranging in their own sectors was collected and then financial data from 2002 to 2012 was used to run pooled regression in order to find out any existing relationship
The results were pretty astonishing as it was proved that leverage had no impact on either of the equity elements. Nevertheless, a relationship could be identified between leverage and expected stock returns. Hence it will be safe to conclude that Pakistan’s economy is shortsighted and consumption oriented and that profits and earnings of companies in Pakistan are highly financed by their respective revenues. But nevertheless judgments about a particular sector couldn’t be made as this report has various business sectors of Pakistan.
Financial Management
We Also Provide SYNOPSIS AND PROJECT.
Contact www.kimsharma.co.in for best and lowest cost solution or
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Deals with theories of capital structure, changed reality and irrelevance leverages and acceptance of zero debt capital structure and a case study of DLF India falling from the sky
This presentation is an overview of Capital Structure Theories.
Dr. Soheli Ghose ( Ph.D (University of Calcutta), M.Phil, M.Com, M.B.A., NET (JRF), B. Ed).
Assistant Professor, Department of Commerce,St. Xavier's College, Kolkata.
Guest Faculty, M.B.A. Finance, University of Calcutta, Kolkata
Financial Management
We Also Provide SYNOPSIS AND PROJECT.
Contact www.kimsharma.co.in for best and lowest cost solution or
Email: amitymbaassignment@gmail.com
Call: 9971223030
Effect of operating, financial and total leverage on expected stock return an...Shoaib Lalani
Regardless of the size and nature, largely all businesses are dependent on leverage. This research called for analyzing the impact of leverage on equity elements like the earnings to price ratio, Market value of equity and book to market ratio. Later on we also tested to identify the relationship between leverage and on expected stock returns. Financial data for different companies ranging in their own sectors was collected and then financial data from 2002 to 2012 was used to run pooled regression in order to find out any existing relationship
The results were pretty astonishing as it was proved that leverage had no impact on either of the equity elements. Nevertheless, a relationship could be identified between leverage and expected stock returns. Hence it will be safe to conclude that Pakistan’s economy is shortsighted and consumption oriented and that profits and earnings of companies in Pakistan are highly financed by their respective revenues. But nevertheless judgments about a particular sector couldn’t be made as this report has various business sectors of Pakistan.
Financial Management
We Also Provide SYNOPSIS AND PROJECT.
Contact www.kimsharma.co.in for best and lowest cost solution or
Email: amitymbaassignment@gmail.com
Call: 9971223030
Deals with theories of capital structure, changed reality and irrelevance leverages and acceptance of zero debt capital structure and a case study of DLF India falling from the sky
This presentation is an overview of Capital Structure Theories.
Dr. Soheli Ghose ( Ph.D (University of Calcutta), M.Phil, M.Com, M.B.A., NET (JRF), B. Ed).
Assistant Professor, Department of Commerce,St. Xavier's College, Kolkata.
Guest Faculty, M.B.A. Finance, University of Calcutta, Kolkata
The ppt speaks about the term 'Capital Structure', its factors influencing, the theories and its basic assumptions which make the topic easy to decode and understand.
2. Capital Structure decision is relevant to the
valuation of the firm.
In other words, a change in the financial leverage
will lead to a corresponding change in the overall
cost of capital as well as the total value of the firm.
If therefore the degree of financial leverage as
measured by the ratio of debt to equity is
increased, the WACC will decline, while the value
of the firm as well as the market price of share will
increase and vice versa.
3. First there are no taxes.
Second the cost of debt is less than the cost of
equity.
Third the use of debt does not change the risk
perception of investor.
4. A company’s expected annual EBIT is Rs. 50000. The
company has Rs 2,00,000, 10% debenture. The cost of
equity of the company is 12.5%.
5. Net Operating Income (EBIT) Rs 50,000
Less: Interest on debentures (I) 20,000
---------------------------
Earnings available to equity holders (NI) 30,000
Equity Capitalization Rate (ke) 0.125
Market Value of Equity (S) = NI/Ke ----------------------------
2,40,000
Market Value of Debt (B) 2,00,000
Total Value of the firm (S+B) = V ------------------------------
4,40,000
Overall cost of capital = Ke = EBIT/V (%) 11.36
Alternatively: Ko = Ki (B/V) + Ke (S/V)
6. The essence of this approach is that the capital
structure decision of a firm is irrelevant.
Any change in leverage will not lead to any
change in the total value of the firm and the
market price of shares as well as the overall
cost of capital is independent of the degree of
leverage.
7. Overall cost of capital is constant
Residual value of Equity:
Total market value of equity capital = V - B
Changes in cost of equity capital:
Ke increases with the degree of leveraging.
8. A company’s expected annual EBIT is Rs. 50000. The
company has Rs 2,00,000, 10% debenture. The cost of
equity of the company is 12.5%.
Ke = (EBIT – I)/(V – B)
= Earning available to equity holders/Total
market value of equity shares
9. Net Operating Income (EBIT) Rs. 50,000
Overall capitalisation rate (Ko) 0.125
-----------------------------
Total market value of the firm (V) = EBIT/Ko Rs 4,00,000
Total Value of Debt Rs 2,00,000
Total Market Value of Debt (S) = (V – B) Rs 2,00,000
10. MM approach support the NOI approach, it
means capital structure and cost of capital is
irrelevant to value of the firm.
Basic Propositions of the MM approach
-- The overall cost of capital (ko) and the value of
the firm (V) are independent of its capital
structure. The total value is given by capitalizing
the expected stream of operating earnings at a
discount rate appropriate for its risk class.
-- Ke increases in a manner to offset exactly the
use of a less expensive source of funds
represented by debt.
11. The MM approach illustrates the arbitrage process with
reference to valuation in terms of two firms which are
exactly similar in all respects except leverage so that
one of them has debt in its capital structure while the
other does not.
To understand the process let us have an example
12. Assume there are two firms, L and U, which are
identical in all respects except the firm L has 10% Rs
5,00,000 debentures. The EBIT of both the firms are
equal, that is, Rs 1,00,000. The equity capitalization
rate (Ke) of firm L is higher (16%) then that of firm U
(12.5%).
Solution: