BU393 Chapter Notes - Chapter 16: Arbitrage, Capital Structure
Document Summary
The capital structure question and the pie theory. Pie model a model of the firm"s debt-equity ratio. It graphically depicts slices of pie that represent the value of the firm in the capital markets. Changes in capital structure benefit the shareholders if and only if the value of the firm increases. A risk-averse investors will prefer an all-equity firm, while a risk-neutral investor might prefer leverage. Mm proposition i a proposition of modigliani and miller (mm) stating that a firm cannot change the total value of its outstanding securities by changing its capital structure proportions. The value of the levered firm is the same as the value of the unlevered firm. If levered firms are priced too high, rational investors will arbitrage by borrowing on their personal accounts to buy shares in unlevered firms. As long as individuals borrow (and lend) on the same terms as the firms, they can duplicate the effects of corporate leverage on their own.
