《《17 The Cost of Capital》.pdf

The American economic Revlew VOLUME XLVIII JUNE 1958 NUMBER THREE THE COST OF CAPITAL, CORPORATION FINANCE AND THE THEORY OF INVESTMIENT By FRANCO MODIGLIAN1 AND MERTON H. MILLER* What is the cost of capital to a firm in a world in which funds are used to acquire assets whose yields are uncertain; and in which capital can be obtained by many different media, ranging from pure debt instru- ments, representing money-fixed claims, to pure equity issues, giving holders only the right to a pro-rata share in the uncertain venture.? This question has vexed at least three classes of economists: (1) the cor- poration finance specialist concerned with the techniques of financing firms so as to ensure their survival and growth; (2) the managerial economist concerned with capital budgeting; and (3) the economic theorist concerned with explaining investment behavior at both the micro and macro levels. In much of his formal analysis, the economic theorist at least has tended to side-step the essence of this cost-of-capital problem by pro- ceeding as though physical assets-like bonds-could be regarded as yielding known, sure streams. Given this assumption, the theorist has concluded that the cost of capital to the owners of a firm is simply the rate of interest on bonds; and has derived the familiar proposition that the firm, acting rationally, will tend to push investmnent to the point * The authors are, respectively, professor and associate pr