15 Apr 2022



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All businesses inexorably operate within a particular market environment (Saunder & Cornett, 2014). The Modigliani-Miller theorem was propounded by Franco Modigliani and Merton Miller. Following this proposition of this theorem, Modigliani was bestowed a Nobel Prize in Economics in 1985. Miller, then a tenured faculty member of the University of Chicago, was awarded a Nobel Prize in Economics in 1990. 

Modigliani-Miller theorem is simply an iteration of a firm’s market value (Opler & Titman, 1994). At its core, the Modigliani-Miller theorem exemplifies that an organizations’ worth is independent of its source of financing. This, however, holds merit only in the absence of such liabilities as taxes, agency costs (Miller & Modigliani, 1977). 

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The proposition of this theorem is purely hypothetical since in a corporeal scenario, taxes are collected. What is the relevancy of this theorem to the endeavor of debt financing? Usually, a company can pursue three key ways in the quest to gain capital for financing its multifarious projects:

Seeking capital from debt

Disbursing earnings

Selling shares

The theorem suggest that the worth of two companies, one unlevered to suggest that it is leveraged by equity, and another levered to propose that its leveraged by both equity and debt, then the worth of the two companies are identical (Miller & Modigliani, 1977). The dynamics of this theorem are only feasible under some assumptions exemplified below:

No execution costs 

The theory holds the notion that all monetary endeavors occur free of charge. This assumption propounds that a company aiming at selling stocks can proceed to do so without the requisite imbursement of an intercessor such as a bank (Opler & Titman, 1994). 

In the corporeal setup, this assumption proves to be apocryphal since monetary endeavors such as buying stocks or bonds never occur at no financial implication.

Egalitarianism of usage

For the theorem to maintain its verity, usage between a firm and its bondholders must be standardized (Saunder & Cornett, 2014). The theorem proposes that regardless of whether a company seeks a loan or a stockholder buys a stake in the company, the culminating outcome remains invariable.

In the real world, this notion fails to hold much merit. This is because usage has the propensity of occurring at varying rates (Opler & Titman, 1994)

Managing surplus money

This assumption waxes the idea that a firm will always be frugal when in possession of extraneous monetary resource. In reality, this notion is further from the truth. In times of relative abundance, most companies tend to be remarkably profligate in the use of resources. 

Calculation With No Consideration of Taxes

Consider the following parameters in order to calculate the cost of equity of a levered firm:

Earnings Before Interest and Taxes (EBIT)= $500,000

Rate of return on equity (Re) = 14%

Rate of return on debt (Rd) = 8%

Debt to Equity ratio (D/E) = 1,000,000/500,000=2

Applying the Miller Modigliani theorem, the following deduction can be arrived at:

Vu = Vl

But 14% of Equity = EBIT

Vl = Vu = 500000(100/14) = 25,000,000/7

But Vl = Equity + Debt

Equity = 25,000,000/7 + 1,000,000

Considering the Miller-Modigliani model, 

Rl = Re (Unlevered) + D/E [Rl (Levered) + Rd]

Rl= 14/100 + 1000000/ [25000000/7+1000000] + 8/100

= 0.2585%

A levered company is that which has resorted to debt financing while an unlevered company is that which is using equity financing (Opler & Titman, 1994).

Calculation with a consideration of taxes

Consider the following known variables of the 2 firm’s performance assuming that a 40% tax is imposed on both the companies:

EBIT = $500,000

Re = 14%

Rd = 8%

Tc = 40%

Debt to Equity ratio = 1000000/ [ 25,000,000/7+ 1,000,000]

Re = Ro +D/E (Ro – Rd) (1 – Tc)


Re is the rate of return on equity.

Ro is the rate of unlevered equity. 

Rd is the rate of debt.

Tc is the tax rate.

Vl = Vu + Tc (Debt)

Vu= 25000000

Vl = 25000000/7 + 40/100(1,000,000)


Calculation of adjusted present value (APV)

Adjusted present value (APV) refers to the mothod of calculating the value of the company from its earnings before taxes and interst, plus the non cash items deducting the working capital changes and othe operation cost and adjusting it after the effects of tax shielding and deductions of debt.

Earning before interest and taxes(EBIT) – 40/100EBIT

=0.6(EBIT) representing the the net operating profit after tax

Deducting the cost of future investment, that is the resturn on incestment 

=0.6(EBIT)- 0.1(EBIT) we get value of unlevered Assets

Adding 7% of the of the investment we get the levered value of the company which is

=0.6(EBIT) - 0.1(EBIT) + 0.07(18,000,000)

After deducting the debt of the company we get the adjusted Present Value as:

= $1,510,000

The weighted average cost of capital is the evaluation of a companies’ capital cost against a backdrop of capital used as a scale.

WACC = (DKd + EKe)/ (D + E)

= 1000000(8/100) + 4571428.571(14/100)


= 0.1292

Calculations of horizontal unlevered value operations:




g= (FCF3- FCF2)*100=9.375u

Rsu =14%

horizontal unlevered value operations=320,000(1+0.09375)/0.14-.0.09375

= 7,567,567.568

Calculations of current horizontal unlevered value operations:



Rsu =14%

horizontal unlevered value operations=320,000(1+0.07)/0.14-0.07= 489428.57

Tax Savings= (interest expense)(tax rate)



Calculations of horizontal unlevered value operations:


g= (TS3- TS2)*100=8.33%

Rsu =14%

horizontal unlevered tax value= 48,000(1+.0833)/0.14+0.0833

= 90,425.49

Tax Savings= (interest expense)(tax rate)



Calculations of horizontal unlevered value operations:


g= 7%

Rsu =14%

Estimated Horizontal unlevered tax value= 48,000(1+7)/0.14+7

= 53,781.51

Voperations= Vunlevered +Vshield = 579,854.06

489428.57+90425.49 = 579,854.06


Miller Modigliani theorem iterates that the value of company, regardless of whether it’s financed by equity or debt, is a constant provided some assumptions are brought into play. 

This is exemplified by the equation Vu=Vl (Miller & Modigliani, 1977).

However, the model also propounds that value of a company is equal to the cost of equity plus the debt. Hence, if a company resorts to a large amount of debt financing, in order for the equation to hold, the cost of equity must also rise in similar proportion. 

This results in an increase of the amount of dividends that a company must pay to its shareholders. In order to maintain the same value, the stock prices must invariably go down. 

The use of debt to leverage assets is a method emerging companies use to gain an edge in an already competitive market. The level of debt must however be curtailed within acceptable limits in order to balance the equity already accrued by the firm.

The Miller Modigliani model provides a lucid and detailed insight into the market value of a company. In the corporeal world, the assumptions propounded by the Miller and Modigliani model hold no merit. The model still does provide a very significant insight into the true market value of a company. 

Upon comparison of tax rates of applied on the equity and that applied on the loans as well as the costs of doing either of the two should pick the one that is lower in cost. The cost of the debt as in refrence to the company is lower than industry standard meaning the value of equity is high upon application of the theorem, Vu=Vl.. therefore the company has ability to absort more debt as compared to other companies in the industry, and share price would likely be higher than that of other companies with industry level debt levels. 

In conclusion the company would be a good investment considering the cost of debt is at 14%. The market ambience values the cost of debt at 30%. This leaves the potential investor with a margin of around 16% leverage debt for the acquisition of assets.


Miller, M. H. (1977). Debt and taxes . the Journal of Finance, 32(2), 261-275.

Opler, T. C., & Titman, S. (1994). The debt-equity choice: An analysis of issuing firms .

Saunders, A., & Cornett, M. M. (2014). Financial institutions management . McGraw-Hill Education,.

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StudyBounty. (2023, September 16). ESTIMATION OF A FIRM’S MARKET VALUE.


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