Session 13: Capital Structure in a perfect World (MM's model)

Question 0

Modigliani-Millier: Proposition I

Answer 0

E+D=U
-> in a perfect capital market, the total value of a firm is equal to the market value of the total CF generated by its assets (and not effected by its capital structure)

Question 1

Capital structure in a perfect world

Answer 1

• capital structure is the mix of equity and debt
• in a perfect world, capital structure choice is irrelevant
• total value of the firm depends on the value of its assets, independently if it’s financed by equity or debt
• average cost of capital is always the same (rWACC does’nt change with capital structure)

Question 2

MM II

Answer 2

rE=rU+D/Ex(rU-rD) rE=cost of levered equity, rU=cost of unlevered equity, D and E MVs
-> the cost of capital of levered equity is equal to cost of capital of unlevered equity plus a premium that is proportional to the MV of Debt-Equity ratio