From Modigliani–Miller To General Theory Of Capital Cost And Capital Structure Of The Company

  • Peter Brusov Finance University
  • Tatiana Filatova Finance University
  • Natali Orehova Finance University
  • Pavel Brusov Finance University
  • Nastia Brusova Finance University
Keywords: Perpetuity Companies, Companies With Finite Lifetime, Companies Of Arbitrary Age, Weighted Average Cost, Equity Cost, Modigliani–Miller Theory, Brusov–Filatova Theorem.

Abstract

One of the serious limitations of the Modigliani–Miller theory

is the suggestion about perpetuity of the companies. We lift

up this limitation and show, that the accounting of the finite

lifetime of the company leads to change of the equity cost,

k  as  well  as  of the  weighted  average  cost  of  capital,

WACC,  in  the  presence  of  corporative  taxes. We  give  a

rigorous  proof  of  the  Brusov–Filatova  theorem,  that  in  the absence  of  corporative  taxes  cost  of  company  equity, , as well as its weighted average cost, WACC, do not depend

on  the  lifetime  or  age  of  the  company.  We  show  that

perpetuity Modigliani­Miller theory underestimates the equity

cost ,  as  well  as  the  weighted  average  cost  of  capital,

WACC,  and  thus  underestimates  the  financial  risks,  which

could  become  one  of  the  implicit  reasons  for  the  financial crisis

 

References

Peter Brusov, Tatiana Filatova, Natali Orehova, Nastia Brusova, Weighted average cost of capital in the theory of Modigliani–Miller, modified for a finite life–time company, Applied Financial Economics, v.21(7) 2011.

Brusov P.N.and T.V. Filatova, 2011, Financial management (Moscow, Knorus).

Filatova T.V., N.P.Orehova, A.P. Brusova, 2008, Weighted average cost of capital in the theory of Modigliani–Miller modified for the finite lifetime of the company. Bulletin of the FA, 4,74–77.

Мodigliani F., Мiller M. 1958, The Cost of Capital, Corporate Finance, and the Theory of Investment. American Economic Review, 48, 261–297.

Мodigliani F., Мiller M. 1963, Corporate Income Taxes and the Cost of Capital: A Correction. American Economic Review, 53, 147–175.

Myers S., 2001, Capital Structure, Journal of Economic Perspectives, 15(2), 81 – 102.

Published
2011-06-07
Section
Articles