Meaning of Modigliani-Miller

Question

Briefly describe the meaning of Modigliani- Miller (M and M) approach?

Answer 1

Modigilani-Miller approach is also termed as MM approach that looks related to Net operating income approach. It is in harmonization with the Net operating income approach and states in recognition with the approach that cost of capital is sovereign of degree of leverage. It offers justification for operational and behavioral for constant cost of capital at any degree of leverage as this is not being offered by the Net operating Income approach. It is been guessed in this approach that capital markets are ideal and the investors are investing in the company since the same expectation of the company's net operating income in search of measuring the value of the firm. The intentions of this approach can be mentioned in the subsequent ways and it is illustrated below:-

i) Company's whole cost of value and capital of the firm is stable at any degree of influence as it is independent of the capital composition.

ii) Capital investment that has the minimum cut-off rate is as well independent of project finances.

If this approach has benefits then it has certain drawbacks associated with it and the drawbacks are illustrated below:-

i) Investors discover the leverages not convenient and risk insight of corporate and personal leverage is dissimilar.

ii) Corporate does not exist however it gets confiscated later.

iii) Arbitrary process does not have any limits and it is as well not be affected through transaction cost.