6. Modigliani and Miller assumptions

In 1958 Franco Modigliani and Merton Miller (MM) published a set of research papers that revolutionized the theory of a corporation's capital structure. In their first research paper, MM proposed a set of assumptions that, on the surface, may seem unrealistic, but these assumptions and MM's algebraic approach provided the first significant attempt to study capital structure theory in a scientific fashion. The original assumptions that were used in MM's first study were changed by MM and other researchers as the theory of capital structure evolved.

Which of the following statements are assumptions that Modigliani and Miller used in their initial (MM Proposition I) model and research paper?

Check all that apply.

?All investors are rational, and have the same expectations of a company's earnings (as measured by its EBIT).

?Complete information is readily available to all investors and is free to all market participants.

?There are no costs associated with a bankruptcy.

?There are no taxeseither personal or corporate.

?A firm's earnings will grow at an unpredictable rate.

?The cost of debt increases with the level of debt.

Consider the following statement about a firm's capital structure:

The value of the firm is independent of its leverage.

Is the preceding statement consistent with the conclusions of Modigliani and Miller's 1958 capital structure theory (MM Proposition I)?

Yes

No