Corporate finance Essay Example | Topics and Well Written Essays - 2000 words - 6

Corporate finance - Essay Example Company’s capital structure can comprise of majority of equity or debt component, an equal combination of both or only one of them. Each approach includes its own advantages as well as disadvantages. The hypothesis on capital structure from the Modigliani & Miller is considered as one of the significant developments or progress in the area of corporate finance (Miller, 1988). The report will highlight the main foundations and implications of Modigliani & Miller approach towards the capital structure. It will also focus on how this theory is related to the purpose of weighted average cost of capital (WACC) for a company. Further, the report will take into consideration the practical applicability and usefulness of the theory in real life business. There are five assumptions of this approach which involves: no taxes; transaction price/cost for selling and buying securities and also the cost of bankruptcy is nil; there is evenness of information which means that the investor will have the right to use the similar information that the corporate would and it also means that the investors are required to behave rationally; the borrowing cost is same for companies as well as investors; and financing of debt does not involve any effect on the firm’s earnings before interest and tax (EBIT). The approach of Modigliani & Miller signifies that the value of leveraged company (i.e. the company having the mixture of equity and debt) is similar to the unleveraged company’s value (i.e. the company which is completely financed by means of equity) if the future prospects and the operating profits are same. It further explains that if the investor buys leveraged firm’s share, it would rate him on the same scale as purchasin g the unleveraged firm’s share (Casamatta, 2003). The theorem of Modigliani & Miller makes the basis of contemporary corporate finance. It defines that this