What are the major assumption of MM model?
MM model assumes that there are no floatation costs and no time gaps are required in raising new equity capital. In the practical world, floatation costs must be incurred and legal formalities must be completed and then issues can be floated in the market.
What are the assumptions of Modigliani and Miller approach?
The Modigliani and Miller Approach further states that the market value of a firm is affected by its operating income, apart from the risk involved in the investment. The theory stated that the value of the firm is not dependent on the choice of capital structure or financing decisions of the firm.
What was the main proposition mm developed in their no tax model?
Modigliani and Miller (MM) Their main conclusions can be summarized as: In the absence of taxes, firm capital structure is irrelevant. With taxes, a firm’s cost of capital can be lowered through issuing debt. This highlights the importance of debt as a tax shield.
What is MM model?
The Modigliani-Miller theorem (M&M) states that the market value of a company is correctly calculated as the present value of its future earnings and its underlying assets, and is independent of its capital structure.
What is Walter’s model?
Walter has developed a theoretical model which shows the relationship between dividend policies and common stocks prices. According to him the dividend policy of a firm is based on the relationship between the internal rate of return (r) earned by it and the cost of capital or required rate of return (Ke).
What are the capital structure theories?
Capital Structure means a combination of all long-term sources of finance. Based on the proportion of finance, WACC and Value of a firm are affected. There are four capital structure theories for this, viz. net income, net operating income, traditional and M&M approach.
What are the four types of capital?
The four major types of capital include debt, equity, trading, and working capital.
Which capital structure theory is the best?
The optimal capital structure of a firm is the best mix of debt and equity financing that maximizes a company’s market value while minimizing its cost of capital. In theory, debt financing offers the lowest cost of capital due to its tax deductibility.
What is traditional theory of capital structure?
The traditional theory of capital structure states that when the weighted average cost of capital (WACC) is minimized, and the market value of assets is maximized, an optimal structure of capital exists. This is achieved by utilizing a mix of both equity and debt capital.
How many types of capital structure are there?
What is the traditional approach?
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What are the assumptions of NOI approach?
The NOI approach is based on following assumptions: (i) There are no corporate taxes. (ii) Cost of debt remains constant at all level of debt. (iii)Overall cost of capital remains constant.
What are the assumptions of net income approach?
The assumptions for the net operating income approach are: Cost of capital is always constant. Value of equity is residual (Derived by subtracting value of debt from value of firm) If amount of debt increases, shareholders required return expectations will increase.
Which of the following is true of NOI approach?
Net income approach suggests that the value of the firm can be increased by decreasing the overall cost of capital (WACC) through higher debt proportion. Hence, higher debt is better is the true statement for net income approach.
What are the features of sound capital structure?
Some of the major features of sound capital structure are as follows: (i) Maximum Return (ii) Less Risky (iii) Safety (iv) Flexibility (v) Economy (vi) Capacity (vii) Control.
Why is capital structure important?
Reduces Financial Risk: Balancing the proportion of debt and equity in the business through capital structure assist the business firms in managing and minimizing risk. Minimizes Cost of Capital: It provides for planning the long term debt capital of the company strategically and thus reducing the cost of capital.
What are the major determinants of capital structure?
The capital structure of a concern depends upon a large number of factors such as leverage or trading on equity, growth of the company, nature and size of business, the idea of retaining control, flexibility of capital structure, requirements of investors, cost of floatation of new securities, timing of issue.
What is the meaning of capital structure define its features?
The capital structure is the particular combination of debt and equity used by a company to finance its overall operations and growth. Debt comes in the form of bond issues or loans, while equity may come in the form of common stock, preferred stock, or retained earnings.
What are the factors affecting the capital structure?
Size, profitability, tangibility, growth opportunity, equity turnover, dividend paying and maturity are used as the firm’s specific variables that affect a firm’s capital structure decision.
What is capital structure and its factors?
Capital Structure is referred to as the ratio of different kinds of securities raised by a firm as long-term finance. The capital structure involves two decisions- Type of securities to be issued are equity shares, preference shares and long term borrowings (Debentures).