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Franco Modigliani Presented by 036
Franco Modigliani Presented by 036
Content of Presentation
1.
2.
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4.
5.
1944: Franco Modigliani obtained his D. Soc. Sci. from the New
School for Social Research.
The
The Collected
Collected Papers
Papers o
o
ff Franco
Modigliani
Franco Modigliani
The
The Collected
Collected Papers
Papers of
of
Volume
Volume 5:
5: Savings,
Savings, Def
Def
icits,
icits, Inflation,
Inflation, and
and F
F
inancial
Theory
inancial Theory
published
published 1989
1989
published
published 2005
2005
The
The Debate
Debate Over
Over Stabili
Stabili
zation
zation Policy
Policy
published
published 1986
1986
The
The Collected
Collected Papers
Papers of
of
Monetary
Monetary Theory
Theory and
and St
St
abilization
abilization Policies
Policies
published
published 1989
1989 ,,
The
The European
European Ec
Ec
onomic
onomic Recovery
Recovery
:: A
A Need
Need for
for Ne
Ne
w
Policies?
w Policies?
The
The Collected
Collected Papers
Papers
of
of Franco
Franco Modigliani,
Modigliani,
Volume
Volume 1:
1: Essays
Essays in
in
Macroeconomics
Macroeconomics
published
published 1980
1980
The
Of
An
The Collected
Collected Papers
Papers o
o Adventures
Adventures
OfPension
An Economi
Economi
Rethinking
Rethinking
Pension
ff Volume
3:
The
Theory
Volume 3: The Theory st
st Reform
Reform
of
of Finance
Finance and
and Other
Other
published
published 2004
2004
Essays
Essays
Foundations of Financ
ial Markets and Insti
tutions
published 1901
Investment
Management
Published 1995
Sostenibilita E Solvibilita
del Debito Pubblico
in Italia: Il Conto Dei
Flussi E Degli
Stock Della Pubblica
Amministrazione a Livello
Nazionale E Regi
Avventure Di Un
Economista
: La Mia Vita, Le Mie Idee
, La Nostra Epoca
ModiglianiMiller theorem
The theorem was first proposed by F. Modigliani and M. Miller in 1958.
Franco Modigliani, Merton Miller forms the basis for modern thinking on
capital structure. The basic theorem states that, under a certain market
price process (the classical random walk), in the absence of taxes,
bankruptcy costs, agency costs, and asymmetric information, and in an
efficient market, the value of a firm is unaffected by how that firm is
financed .
It does not matter if the firm's capital is raised by issuing stock or selling
debt. It does not matter what the firm's dividend policy is. Therefore, the
ModiglianiMiller theorem is also often called the capital structure
irrelevance principle.
Consider two firms which are identical except for their financial structures. The
first (Firm U) is unlevered: that is, it is financed by equity only. The other
(Firm L) is levered: it is financed partly by equity, and partly by debt. The
ModiglianiMiller theorem states that the value of the two firms is the same.
Without taxes
VU=VL where VU is the value of an unlevered firm = price of buying a
firm composed only of equity, and VL is the value of a levered firm = price
of buying a firm that is composed of some mix of debt and equity.
With taxes
VL = VU +TcD
VL is the value of a levered firm.
VU is the value of an unlevered firm.
TcD is the tax rate (Tc ) x the value of debt (D) debt is perpetual .
This means that there are advantages for firms to be levered, since
corporations can deduct interest payments. Therefore leverage lowers
tax payments. Dividend payments are non-deductible.
Following assumptions are made in the propositions with taxes:
corporations are taxed at the rate on earnings after interest.
no transaction costs exist.
individuals and corporations borrow at the same rate.
Third is that the rational concept of capital cost refer to total cost,
and should be measured as the rate of return on capital invested in
shares of firms in the same risk class.
In the early 1950s, Franco Modigliani and his student, Richard Brumberg,
developed a theory based on the observation that people make
consumption decisions based on the resources available to them over their
lifetime.. They had observed that individuals build up assets at the initial
stages of their working lives. Later on during retirement, they make use of
their stock of assets. The working people save up for their post-retirement
lives and alter their consumption patterns according to their needs at
different stages of their lives.
Assume that there is a consumer who expects that he will live for
another T years and has wealth of W. The consumer also expects
to earn income Y until he retires R years from now.
If every individual in the economy plans his consumption in this manner, then
the aggregate consumption function will be quite similar to the individual one.
Thus, the aggregate consumption function of the economy is
Implications
Moreover, according to the given consumption function, the
average propensity to consume is
We
It was observed average duration of working life and retired life and the
rate of earning is constant till retirement and so is the rate of
consumption combined with a zero rate of return on net worth we can
find that in a stationary economy of constant population and
productivity, the aggregate stock of wealth would be very significant.
If the size of the cohorts born in successive years grows at the rate
p then both population and the aggregate income will grow at the
rate p. As a result of this growth there will be an increase in the ratio
of younger individuals in their earning phase to retired individuals in
their dissaving phase, leading to a positive net flow of saving.
Moreover this implies that the currently working generation will aim
for a level of consumption in their post-retirement years larger than
the consumption enjoyed by the currently retired individuals
belonging to a less affluent generation.
The findings of many economists bring out a problem in the lifecycle model. It was found out that the elderly do not dissave .
There are two explanations for the aforementioned behaviour of the
elderly.
The first explanation is that the retired individuals are cautious about
unpredictable expenses. The additional saving that arises due to
this behaviour is called precautionary saving. Precautionary saving
may be made for the probable event of living longer than expected
and hence having to provide for a longer than the planned span of
retirement. Another rational reason is possibility of ill-health and
huge medical expenses.
The second explanation is that the elderly may save more
in order to leave bequests to their children. This will
discourage dissaving at the expected rate.
Contribution of Modigliani
Developed sub models of private consumption and the financial sector,
studied the consequences for household saving of changes in
demography and economic growth, and laid the foundation for the
field "corporate finance.
Died
Franco
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MBA3.5(5th)
3/18/15