Overview
The Modigliani Miller theorem asserts that under a set of specified conditions,- no taxes
- no bankruptcy costs
- symmetric information
- equal borrowing costs
the value of a firm is independent of capital structure.
Formulation
The assumptions imply that
{% V_E = \mathbb{E}(max(0,V-D)) %}
{% V_D = \mathbb{E}(min(V,D)) %}
where
- {% D %} is the stated principal of the company's debt
- {% V_E %} is the value of equity
- {% V_D %} is the value of debt
- {% V %} is the value of the firm
Then we have,
{% V_E + V_D = \mathbb{E}(max(0,V-D)) + \mathbb{E}(min(V,D)) = \mathbb{E}(V) %}