Page 354 - Corporate Finance PDF Final new link

NPP

354 Corporate Finance BRILLIANT’S

EBIT 4,00,000
K =  = 0.1273 or 12.73%
o V 31,42,857
Conclusion: Company should accept the proposal because the market value of the firm will
increase and the overall cost of capital will decrease.

Q.37. What are the assumption used in Modigliani-Miller approach?
_mo{X½bmZr-{_ba EàmoM ‘| {H$Z-{H$Z ‘mݶVmAm| H$m à¶moJ {H$¶m OmVm h¡?
OR
Write a short note on modigliani and miller approach.
_mo{X½bmZr Am¡a {_ba EàmoM na EH$ g§{jßV {Q>ßnUr {b{IE&

Modigliani-Miller (MM) Approach _mo{X½bmZr-{_ba (MM) EàmoM
In 1958, Modigliani and Miller (MM) wrote 1958 _| _mo{X½bmZr-{_ba Zo EH$ _hÎdnyU© boI
an important article, which provided a base for {bIm {Oggo ZoQ> Am°naoqQ>J BÝH$‘ H$s AdYmaUm H$mo AmYma
the net operating income approach. They ar-
{_bmŸ& CÝhm|Zo VH©$ {X`m {H$ `{X H$a H$mo Ü`mZ _| Z aIm
gued that in the absence of taxes, a firm's mar- OmE Vmo H¡${nQ>b ñQ´>ŠMa _| n[adV©Z Ho$ ~mX ^r \$_© H$s
ket value and the cost of capital remains con-
stant to the capital structure changes. In their _mH}$Q> d¡ë`y Ed§ H¡${nQ>b H$s H$m°ñQ> pñWa ahVr h¡Ÿ& boI _|
article, they provided analytically sound and CÝhm|Zo Bg AdYmaUm H$mo VH©$nyU© T>§J go {díbo{fV H$aVo
logical justification of their hypothesis. hþE àñVwV {H$`mŸ&
Modigliani and Miller argued that the av- _mo{X½bmZr-{_ba Zo VH©$ {X`m {H$ {H$gr H$ånZr H$s
erage cost of capital of a firm is completely Am¡gV H$m°ñQ> Am°’$ H¡${nQ>b CgHo$ H¡${nQ>b ñQ´>ŠMa go
independent of its capital structure. In other
words, a change in the debt-equity ratio does Aà^m{dV ahVr h¡Ÿ& AÝ` eãXm| _|, S>oãQ> Bp³dQ>r aoemo go
not affect the cost of capital. They gave a simple H$m°ñQ> Am°’$ H¡${nQ>b na H$moB© à^md Zht n‹S>VmŸ& AnZr Bg
argument in support of their approaches. They _mÝ`Vm Ho$ nj _| do EH$ gm_mÝ` VH©$ XoVo h¢Ÿ& CZH$m VH©$
argued that according to the traditional ap- `h h¡ {H$ naånamJV AdYmaUm Ho$ AZwgma, H$m°ñQ> Am°’$
proach, cost of capital is the weighted average
of cost of debt and cost of equity. The cost of H¡${nQ>b, S>oãQ> Ed§ Bp³dQ>r H$s ^m[aV bmJV H$m Am¡gV
equity is determined from the level of hmoVm h¡Ÿ& Bp³dQ>r H$s H$m°ñQ> Bg ~mV na {Z^©a H$aVr h¡
shareholder’s expectations. For example, Now {H$ eo¶a hmoëS>a AnZr BÝdoñQ>oS> H¡${nQ>b na {H$VZo [aQ>Z©
if shareholder’s expect 16% from a particular H$s Anojm H$aVo h¢Ÿ& CXmhaU Ho$ {b`o, `{X do 16% [aQ>Z©
company, they take into account, the debt-eq-
uity ratio and they expect 16% merely because H$s Anojm H$aVo h¢ Vmo BgH$m A{^àm` h¡ {H$ do _mZVo h¢ {H$
they find that 16% cover the particular risk. 16% [aQ>Z© go CZH$s Omo{I_ H$da hmo Om`oJrŸ&
Now, if there is any increase in risk, the A~ `{X Omo{I_ ~‹T>Vr h¡ Vmo A§eYmar, H$ånZr go
shareholders will expect a higher rate of re- A{YH$ [aQ>Z© H$s Anojm H$a|JoŸ& Bg àH$ma S>oãQ> Bp³dQ>r
turn from the shares of the company. There- {‘³g _| n[adV©Z H$m à^md ñdV: hr eo¶a hmoëS>g© Ho$
fore, each change in the debt-equity mix is
automatically off-set by a change in the expec- Ano{jV [aQ>Z© go g_m`mo{OV hmo OmEJmŸ& Bg H$maU go
tations of the shareholders from the equity _mo{X½cmZr Am¡a {_ca `h VH©$ XoVo h¢ {H$ crdaoO H$m