1. There are only two sources of funds used by a firm: perpetual riskless debt and ordinary shares.
2. There are no corporate taxes. This assumption is removed later.
3. The dividend-payout ratio is 100. That is, the total earnings are paid out as dividend to the shareholders as there are no retained earnings.
4. The total assets are given and do not change. The investment decisions are, in other words assumed to be constant.
5. The total financing remains constant. The firm can change its degree of leverage (capital structure) either by shares and use the proceeds to retire debentures or by raising more debt and reduce the equity capital.
6. The operating profits (EBIT) are not expected to grow,
7. All investors are assumed to have the same subjective probability distribution of the expected EBIT for a given firm.
8. Business risk is constant over time and is assumed to he independent of its capital structure and financial risk.
9. Perpetual life of the firm.