Task1. Theoretically Modigliani and Miller (1958) took a fairly straightforward view of purpose of a company in the economy. They pointed out which companies take cash from providers of long-term funds, invest it in new projects with positive Net Present Value (NPV) and repay the future net inflows to these fund providers in =form of dividend plus interest.
They showed that there is no relationship between debt and value of the firm and it seems to be good enough in the light of assumptions underlying their model. But, most of these assumptions are unrealistic and untenable.
Required:
Question1. Describe the validity of the Modigliani and Miller (1958) model in real world along with their assumptions.
Task2. “The agency theory concept was primarily formed by Berle and Means (1932), who argued that because of a continuous dilution of equity ownership of large corporations, ownership and control become more and more separated. This condition gives professional managers an opportunity to pursue their own interest instead of that of shareholders. Major effort of researchers has been devoted to models in which capital structure is verified by agency costs”.
Required:
Question1. Discuss in relation to the Agency problem by Jensen and Meckling (1976).