Question

Assume you are the CFO of a fortune 500 firm. If we relax the assumptions underlying Modigliani-Miller Theorem I - capital structure irrelevance theory, how will this affect your capital structure decisions?

Answer 1

Theorm I says change in capital structure has no affect on the value of the enterprise subject to the assumption that no taxes, no trasnction cost, all information is about the market is available. In actual sense these assumption can not stand as assumed because there is no ecomony with out taxes and there has to be transaction cost while raising capital. These effect the decision about which source should be choosen to raise the capital. If there are transaction cost exist the firms can also go with reatined earning instead of debt or equity.