THEORY OF CAPITAL STRUCTURE精选.docVIP

THEORY OF CAPITAL STRUCTURE Determination of an optimal capital structure has frustrated theoreticians for decades. The early work made numerous assumptions in order to simplify the problem and assumed that both the cost of debt and the cost of equity were independent of capital structure and that the relevant figure for consideration was the net income of the firm. Under these assumptions, the average cost of capital decreased with the use of leverage and the value of the firm (the value of the debt and equity combined) increased while the value of the equity remained constant. % Ks Ka Kd Debt/Equity Modigliani and Miller showed that this could not be the case. Their contention was that two identical firms, differing only in their capital structure, must have identical total values. If they did not, individuals would engage in arbitrage and create the market forces that would drive the two values to be equal. Their proof of this proposition was based upon several assumptions (many of which have subsequently been relaxed without changing the results): All investors have complete knowledge of what future returns will be All firms within an industry have the same risk regardless of capital structure No taxes (we will relax this assumption subsequently) No transactions costs Individuals can borrow as easily and at the same rate of interest as the corporation All earnings are paid out as dividends (thus, earnings are constant and there is no growth) The average cost of capital is constant Since no taxes has been assumed, the operating income (EBIT) is equivalent to the net income which is all paid out as dividends. Thus, the value of the firm is equal to Since the value of the firm is equal to the sum of the value of the debt and equity, Substituting the last equation into the preceding equation and solving for Ks Thus, ks must go up as debt is added to the capital structure. % Ks Ka Kd Debt/E