The Modigliani and Miller analysis of capital structure assumes that the companys net operating cash flows are given. Capital structure is irrelevant because, in a perfect capital market with no taxes, the value of this cash flow stream is unaffected by capital structure decisions. One reason why capital structure decisions may be important in practice is that cash flows are not independent of these decisions.

Explain how this could occur for:

(a) company that generates large free cash flow

(b) company that is highly levered.