M & M Theory Essays Examples

M & M Theory
M & M theory was advanced by two professors, Modigliani and Miller in the 1950s. The two studied and analyzed the capital structure theory with intense. The two came up with a hypothesis that in a perfect market, the capital structure employed by a company in the financing of its daily operations does not matter. The two professors made a conclusion that the worth of the corporation is not reliant on its financing decisions or on the way it chooses to distribute its dividends. According to Modigliani and Miller, the risk of the company’s underlying assets as well as its earning power determines the true market value of a company. For the theory advanced by Modigliani and Miller to hold, several assumptions have to be made. The assumptions will include the absence of taxes, transaction costs, and bankruptcy costs. The theory also assumes that both the investors and companies have the same information. This means that the market information is symmetrical. The theory also holds under the assumption that the cost of borrowing is the same between the investors and companies. Another postulation in the theory is that the debt has no effect on the earnings before tax and interest of the company.
Modigliani and Miller were professors. The two were destined to be tutors of corporate finance in Carnegie Mellon University. Neither Modigliani nor Miller had prior teaching experience on corporate finance. As they embarked of their topic, they discovered that the material in existence was inconsistent. They, therefore, decided to face the subject together and that is how the theory came to be. The theory is very important to a company. The theory explains that whether a debt or equity funds the company, its market value is not affected. The company’s earning power determines its market value.