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MM Approach- 1958: without taxation part-2 (in Hindi)
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Heena Malhotra
Believe in Conceptual Learning.

Unacademy user
sir please upload the yesterday's and today's mcqs
Is UGC NET Management and Commerce syllabus same. Can you please post link to the updated syllabus for Management
mam iskaa ques bhii aa skta h kyaa
Heena Malhotra
8 months ago
No
MM approach is still confusing
Heena Malhotra
10 months ago
Yes, it is confusing, but you have to study it 2-3 times than you will automatically get able to understand it. Still you face any problem, I will help you out. ☺️
  1. Capital Structure Decision By Heena Malhotra


  2. Net Income (NI) Approach Traditional Approach Net Operating Income Capital Structure Relevance Theory Capital Structure Theories Capital Structure Irrelevance (NOI) Approach Theory Modigliani-Miller (MM) Approach By Heena Malhotra


  3. The NOI approach is definitional or conceptual and lacks behavioral significance. It does not provide operational justification for irrelevance of capital structure. However, Modigliani-Miller approach provides behavioral justification for constant overall cost of capital and therefore, total value of the firm. MM Approach- 1958: without tax: Modigliani-Miller Approach (MM) MM Approach- 1963: with tax By Heena Malhotra


  4. MM Approach-1958: without tax: This approach describes, in a perfect capital market where there is no transaction cost and no taxes, the value and cost of capital of a company remain unchanged irrespective of change in the capital structure. The approach is based on further additional assumptions like: Capital markets are perfect. All information is freely available and there are no transaction costs. All investors are rational. Firms can be grouped into Equivalent risk classes' on the basis of their business risk. .Non-existence of corporate taxes. By Heena Malhotra


  5. 0) Total market value of a firm is equal to its expected net operating income divided by the discount rate appropriate to its risk class decided by the market. Value of levered firm (Vo) Value of unlevered firm (V) Net Operating Income (NOI) Ko Value of a firm- (ii) A firm having debt in capital structure has higher cost of equity than an un- levered firm. The cost of equity will include risk premium for the financial risk The cost of equity in a levered firm is determined as under: Debt d' Equity Ke = Ko + (Ko-Ko) By Heena Malhotra


  6. (ii) The structure of the capital (financial leverage) does not affect the overall cost of capital. The cost of capital is only affected by the business risk. K.K,and K K, K, K, Degree Leverage It is evident from the above diagram that the average cost of the capital (K) is a constant and not affected by leverage By Heena Malhotra


  7. The operational justification of Modigliani-Miller hypothesis is explained through the functioning of the arbitrage process and substitution of corporate leverage by personal leverage. Arbitrage refers to buying asset or security at lower price in one market and selling it at a higher price in another market. As a result, equilibrium is attained in different markets. This is illustrated by taking two identical firms of which one has debt in the capital structure while the other does not, Investors of the firm whose value is higher will sell their shares and instead buy the shares of the firm whose value is lower. They will be able to earn the same return at lower outay with the same perceived risk or lower risk. They would, therefore, be better off By Heena Malhotra


  8. The value of the levered firm can neither be greater nor lower than that of an unlevered firm according this approach. The two must be equal. There is neither advantage nor disadvantage in using debt in the firm's capital structure. The approach considers capital structure of a firm as a whole pie divided into equity, debt and other securities. No matter how the capital structure of a firm is divided (among debt, equity etc.), there is a conservation of investment value. Since the total investment value of a corporation depends upon its underlying profitability and risk, it is invariant with respect to relative changes in the firm's financial capitalisation According to MM, since the sum of the parts must equal the whole, therefore, regardless of the financing mix, the total value of the firm stays the same. The shortcomin Modigliani-Miller will fail to work because of imperfections in capital market, existence of transaction cost and presence of corporate income taxes. By Heena Malhotra g of this approach is that the arbitrage process as suggested by


  9. When value of levered firm is more than the value of unlevered firm There are two company N Ltd. and M Ltd, having same earnings before interest and taxes ie. EBITof 720,000. M Ltd. is a levered company having a debt oR 1,00,000 @ 7% rate of interest. The cost of equity of N Ltd. is 10% and of M Ltd. is 11.50%. Find out how arbitrage process will e carried on? By Heena Malhotra


  10. Company M Ltd N Ltd EBIT (NOI) Debt (D) 20,000 1,00,oo0 1 1 .50% 7% 20,00oo 1 096 NOI Interest Cost of equity 20,000- 7, 000. Value of equity (S) SM- 1,13,043 1 1.50% 20,000 z 2,0o,000 - 1096 VM 1,13,0431,0o,Oo0 (V SD)-2,13,043 VN = 2,00,000 By Heena Malhotra


  11. MM Approach- 1963: with tax In 1963, MM model was amended by incorporating tax, they recognised that the value of the firm will increase or cost of capital will decrease where corporate taxes exist. As a result, there will be some difference in the earnings of equity and debt-holders in levered and unlevered firm and value of levered firm will be greater than the value of unlevered firm by an amount equal to amount of debt multiplied by corporate tax rate. MM has developed the formulae for computation of cost of capital (K), cost of equity (K.) for the levered firm. Value of levered company Value of an unlevered company + Tax benefit Debt (ii) Cost of equity ina levered company (%):Kw . (Kw-Ka Debt+ Equity By Heena Malhotra