FIN 6409 FIN6409 Week 6 Individual Work 1 (Everest University)

FIN 6409 Week 6 Individual Work 1 (Everest University)

Week 6 Individual Assignment 1

Franco Modigliani and Merton Miller are considered the architects of capital structure theory. They had many ideas regarding capital structure and the implications of that structure on a firm’s performance. Since their first article was published in 1958, many financial theorists have attempted to test the validity of existing capital theories. This assignment will allow you to take a look at some major capital structure theories and how they influence finance.

Please respond the following prompts for this assignment:

• What does the following statement mean to you? “One type of leverage affects both EBIT and EPS. The other type affects only EPS.”

Operating leverage affects EBIT and, through EBIT, EPS.  Financial leverage has no effect on EBIT--it only affects EPS, given EBIT.

• What conclusions did Modigliani and Miller draw regarding the effect of capital structure on a firm’s value and cost of capital, assuming no corporate taxes?

◦ How do their conclusions change when each introduces corporate taxes? Explain.

◦ If a firm’s managers thought that Modigliani and Miller were exactly right, what capital structure would they choose to maximize their firm’s value? Why?