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MM Approach- 1963: with taxation (in Hindi)
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Heena Malhotra
Believe in Conceptual Learning.

U
Unacademy user
enjoying your tricks and methods ..........
M
mam 1958 me b to exist ho rhe h tax last m btaya aapne
thank u so much mam... i have no words.... how to appreciate u mam... god bless u.... ☺☺☺
xam k point of view se konsi important hai,with tax or without tax?
nice explanation madam. thank you so much... but how to remember all these points.... any trick... please madam boldijiye
  1. Capital Structure Decision By Heena Malhotra


  2. 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


  3. MM Approach- 1963: with tax o 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. o 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. By Heena Malhotra


  4. MM has developed the formulae- o (i) Value of levered company- Value of an unlevered company+ Tax benefit By Heena Malhotra


  5. 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


  6. 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


  7. 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


  8. 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


  9. (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


  10. 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