Question
Modigliani and Miller developed a theory describing a firm's optimal capital structure, ranging from a basic model assuming no corporate taxes, to an intermediate model
Modigliani and Miller developed a theory describing a firm's optimal capital structure, ranging from a basic model assuming no corporate taxes, to an intermediate model including corporate taxes, and ultimately a model providing for costs of financial distress.
Required (
Requirement-A.By reading the case below,explain which of these models would be applicable to that company.
The Chief Financial Officer (CFO) of the Q14.05T Company is interested to identify the cost of capital and value of the company. Currently,theQ14.05Tis an all-equity company. Earnings before interest and taxes (EBIT) for the company is expected to be $86,198 forever, and the cost of capital is currently 14.05 percent. The corporate tax rate applicable to this company is 32.0 percent.
Market Value of firm = $ 417186.05
New value of firm = $ 399209.61
New Value of Equity = $ 364630.61
New cost of equity = 15.382 %
Wacc = 14.683 %
Requirement-BGive examples of the type of practical companies where each of these three models would be applicable. Justify your answer.
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