The Modigliani & Miller Theory is based on three key assumptions. Are these assumptions reasonable? What are the implication if the assumptions do not hold?

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Sixta KovacekLv2

5 Aug 2019

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An unlevered firm has a market value of $10 million, with $1 million of its assets in cash. With 500,000 shares outstanding, its current stock price is $20.

a) Under the assumptions of Modigliani-Miller, what is the effect on the stock price of an announcement of a $1 special dividend to be paid in 6 months?

b) Find the new stock price after the ex-dividend date.

c) Assume that firm decides to repurchase $500,000 worth of stock instead. Under the assumptions of Modigliani-Miller, what happens to the share price after the repurchase takes place?

d) Assume now that the personal tax rate exceeds the capital gains tax rate. Will investors prefer the dividend or share repurchase? What happens to the stock price at announcement if the firm decides to pay a special dividend?

1. What is do we mean by âriskâ in the finance discipline? Pick a stock and calculate the âriskâ based on the last 250 trading days.

14. Give an example (of each) of a test you could conduct that would refute strong form, semi-strong form, and weak form efficiency.

15. What is the pecking order theory? Name a company that probably uses pecking order in their capital budgeting decisions

16. What did Modigliani and Miller do that is significant in finance? What assumptions did they make to prove their hypothesis?

17. Look up the WACC of a large company and report the capital structure of the firm.

1. Which capital structure theory recognizes the fact that investors and managers do not have the same information regarding a firmâs prospects?

2. The capital structure that maximizes the stock price is also the one that the___________ WACC.

3. In Modigliani & Millerâs Proposition I with taxes the value of a levered firm is equal to the value of an unlevered firm plus____________ .

4. In Modigliani & Miller without taxes, what is the optimal debt to equity ratio?

5. The trade-off theory of capital structure states that debt initially adds value. Explain why

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The Modigliani & Miller Theory is based on three key assumptions. Are these assumptions reasonable? What are the implication if the assumptions do not hold?

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