Financial Management: Core Concepts, Third Edition

16.5 Modigliani and Miller on Optimal Capital Structure

We now turn to a theoretical model of capital structure that begins with a simple assumption: a firm’s investing decision and financing decision are separable. Firms first select what products or services they will produce (the investing decision) and then select how best to finance these products or services (the financing decision). Although the initial decision of what products and services it should produce has a much larger effect on the firm’s profitability, the financing decision is still an important consideration.

Capital Structure in a World of No Taxes and No Bankruptcy

In 1956, two finance professors examined optimal capital structure and concluded that the financing decision ...