Scribd
Upload
717 views5 pages

Modigliani-Miller Model Summary

The document summarizes the Modigliani-Miller model with and without taxes. It presents two key propositions: 1) The value of a firm is equal to its earnings divided by the cost of capital, whether the firm is levered or unlevered. 2) The cost of equity is equal to the cost of capital plus a premium for financial risk. The levered firm has a higher cost of equity than the unlevered firm. When taxes are included, the cost of debt is reduced by taxes paid, but the cost of equity and weighted average cost of capital formulas remain the same. An example application is also provided to illustrate the model without taxes.

Uploaded by

Anis Sofiya
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
717 views5 pages

Modigliani-Miller Model Summary

The document summarizes the Modigliani-Miller model with and without taxes. It presents two key propositions: 1) The value of a firm is equal to its earnings divided by the cost of capital, whether the firm is levered or unlevered. 2) The cost of equity is equal to the cost of capital plus a premium for financial risk. The levered firm has a higher cost of equity than the unlevered firm. When taxes are included, the cost of debt is reduced by taxes paid, but the cost of equity and weighted average cost of capital formulas remain the same. An example application is also provided to illustrate the model without taxes.

Uploaded by

Anis Sofiya
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
  • Overview of MM Model: Provides a summary of the Modigliani and Miller propositions with respective formulas and concepts without and with taxes.
  • Application of Propositions Without Taxes: Explores specific applications of Modigliani and Miller propositions in a no-tax environment, using financial metrics and calculations.
  • Application of Propositions With Taxes: Analyzes scenarios applying Modigliani and Miller propositions considering taxes, detailing impacts on unlevered and levered firms.
  • Detailed Proposition Analysis: Delves into detailed analysis of Proposition II, emphasizing tax implications on financial structures and outcomes.

Summary of MM Model:

WITHOUT TAXES WITH TAXES


Unlevered Levered Unlevered Levered
VU = EBIT (1-Tc) VL = EBIT (1-Tc) + TcB
Proposition I VU = VL = EBIT / ro VL = VU = EBIT / ro ro ro

rs = ro + B (ro – rB) rs = ro + B (ro –rB)(1-Tc) rs = ro + B (ro –rB)(1-Tc)


Proposition II rs = ro + B (ro – rB) S S S
S rs ≠ ro ; rs (L) > rs (U) r s = ro rs ≠ ro
rs = ro

B (rB)(1- Tc) + S (rs)


B (rB) + S (rs) B (rB) + S (rs)
B+S B+S B (rB)(1- Tc) + S (rs)
B+S B+S B+S B+S
rWACC B+S B+S

rWACC = rs = ro
rWACC = rs = ro rWACC (L) = rWACC (U) = ro

Additional Formula:
1) To determine the value of the levered firm in another way: VL = EBIT (1-Tc) / rWACC

2) To determine the value of the levered equity in another way: SL = (EBIT – rBB) x (1 – Tc) / rs
EXAMPLE: APPLICATION OF MODIGLIANI AND MILLER PROPOSITION (NO TAXES):

Unlevered Levered
Assets RM8,000 RM8000
Debt (B) 0 RM4,000
Equity (S) RM8,000 RM4,000
Interest rate (rB) 10% 10%
EBIT RM1,200 RM1,200
Market value/share RM20 RM20
No. of shares 400 shares 200 shares

WITHOUT TAXES

Unlevered Levered

Proposition I VU = VL = EBIT / ro VL = VU = EBIT / ro

rs = ro + B (ro – rB)
Proposition II rs = ro + B (ro – rB) S
S rs ≠ ro ; rs (L) > rs (U)
rs = ro
B (rB) + S (rs) B (rB) + S (rs)
rWACC B+S B+S B+S B+S

rWACC = rs = ro rWACC (L) = rWACC (U) = ro

WITH TAXES

Unlevered Unlevered

VU = EBIT (1-Tc) VL = EBIT (1-Tc) + TcB


Proposition I ro ro

rs = ro + B (ro –rB)(1-Tc) rs = ro + B (ro –rB)(1-Tc)


Proposition II S S
rs = ro rs ≠ ro

B (rB)(1- Tc) + S (rs)


B+S B+S B (rB)(1- Tc) + S (rs)
rWACC B+S B+S

rWACC = rs = ro
rs = ro + B (ro –rB)(1-Tc) rs = ro + B (ro –rB)(1-Tc)
Proposition II S S
rs = ro rs ≠ ro

B (rB)(1- Tc) + S
(rs)
B (rB)(1- Tc) + S
B+S B+
(rs)
S
rWACC
B+S B+S

rWACC = rs = ro

Summary of MM Model: WITHOUT TAXES WITH TAXES Unlevered Levered Unlevered Levered Proposition I VU = VL = EBIT / ro VL = VU =
EXAMPLE: APPLICATION OF MODIGLIANI AND MILLER PROPOSITION (NO TAXES): Unlevered Levered Assets RM8,000 RM8000 Debt (B) 0 RM4,
rWACC B (rB) + S (rs) B + S B + S rWACC = rs = ro B (rB) + S (rs) B + S B + S
Proposition II rs = ro + B (ro –rB)(1-Tc) S rs = ro rs = ro + B (ro –rB)(1-Tc) S rs ≠ ro rWACC

You might also like