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MODIGLIANI-MILLER (MM) APPROACH

The Modigliani-Miller Thesis relating to the relationship between the capital structure, cost of capital and valuation is akin to the NOI Approach. The NOI Approach, as explained above, is definitional or conceptual and lacks behavioral significance. The NOI Approach, in other words, does not provide operational justification for the irrelevance of the capital structure. The MM proposition supports the NOI Approach relating to the independence of the cost of capital of the degree of leverage at any level of debt-equity ratio. The significance of their hypothesis lies in the that it provides behavioral justification for constant overall cost of capital and, therefore, total e of the firm. In other words, the MM Approach maintains that the weighted average (overall) cost of capital does not change, as shown with a change in the proportion of debt to

Leverage and Cost of Capital (MM Approach)

Leverage and Cost of Capital (MM Approach)

equity in the capital structure (or degree of leverage). They offer operational justification for this and are not content with merely stating the proposition.

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