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Chapter 4

Modigliani and Miller’s (M&M’s) gearing

theories

4.1 M&M's key assumptions

 There exists a perfect capital market in which there are no information costs or
transaction costs.

 Debt is risk free and k d remains constant at all levels of gearing.

 Investors are indifferent between personal and corporate gearing.

 Investors and companies can borrow at the same rate of interest.

4.2 M&M's no tax theory

Under M&M’s theoretical assumptions, and in the absence of tax, the
two opposing factors cancel out exactly, so the WACC (and business
value) is constant at all levels of gearing.

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