Modigliani and Miller Proposition I and II structure, interest, because, capital, without

jcfa2011

Am I summarizing this correctly?

MM without taxes:
I: capital structure is irrelevent because
II: as cost of equity goes down, cost of debt goes up, and vice versa

MM with taxes:
I: There is an optimal capital structure because
II: interest is tax deductible

President1988

I wouldn't look at it this way...MM looks at capital structure from a firm's point of view

just concentrate on knowing without taxes prop 1 deals with value and prop II deals with WACC

profil

Youre close, but a little off i think...

No taxes
MMI - capital structure is irrelevant
MMII - capital structure is irrelevant. Adding more debt (cheaper financing) will increase the cost of equity, and there will be no change to WACC

Taxes
MMI - If there are taxes, firm value is maximized at 100% debt
MMII - if there are taxes, WACC is minimized at 100% Debt

There is then also the static trade off theory

neil1234

Kind of...but easier to remember like this:

In Prop I, you are concerned with VALUE
In Prop II, you are concerned with WACC

MM without tax:
I: VALUE is does not change cause capital structure is irrelevant
II: WACC does not change cause...(cost of equity increases proportionally as amount of Debt in capital structure increases. So WACC does not change as capital structure changes since the benefit of using debt at a lower rate is offset by the increase in the cost of equity due to more debt in cap structure)

MM with tax:
I: VALUE DOES change because of the tax shield of debt. Value is MAXIMIZED when Debt = 100% of capital structure
II: WACC DOES change because of the tax shield of debt. WACC is MINIMIZED when Debt = 100% of capital structure

Static Tradeoff:
If you factor in the costs of financial distress, there is an optimal structure such that WACC is minimized and VALUE is maximized. This occurs when the marginal benefit of debt = marginal cost of financial distress. So 100% debt is not optimal, cause financial distress costs increase as your Debt level increases - and eventually, the benefit of the tax shield will be offset by the fin distress costs. So there is a "tradeoff"