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Discussion 8
The Modigliani and Miller hypothesis to capital approach, proposes that the assessment of an organization is immaterial to the capital structure of the firm (Wood & Sangster, 2015). That is, whether a company has lower debt component or highly leverage there is no bearing on the value of the market. Instead, the market value of a company is merely dependent on the operating proceeds. The firm’s capital structure is the method a firm funds its assets. A firm can fund its activities through either debt, equity or diverse combination of equity and debt (Wood & Sangster, 2015). Modigliani and Miller hypothesis has some assumptions. Foremost, is that there are no levies, the transaction cost for purchasing and selling securities and the bankruptcy is zero. In addition, it assumes that there is symmetry in information. Lastly, it presumes that the cost of borrowing is similar for companies and investors (Atrill & McLaney, 2017).
On the strengths, if the prevailing market situations are perfect, then the shareholders and investors do not care if the return is from stock price increase (Wood & Sangster, 2015). The weaknesses are that in the real world, not of the aforementioned assumptions hold true. Ordinary citizens from any nation have an obligation to pay duty. Additionally, payment for transaction cost for purchasing and selling securities as well as bankruptcy costs is mandatory. Moreover, when an entity issues new stock, they must pay floatation costs (Wood & Sangster, 2015). Lastly, information is present to all participants however; the institutional shareholders are more sophisticated with equipment to scrutinize the stock price. The conclusions by Modigliani and Miller ought to stand true hypothetically but the theory does not hold true in the real world (Atrill & McLaney, 2017).
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