Market imperfections

Market imperfections

  • M&M relaxed assumption of perfect capital market by considering corporate taxation.
  • If we relax perfect market assumption further by considering bankruptcy risk, an optimal capital structure emerges.
  • Companies have to balance the tax efficiency of debt with the risk of bankruptcy.
  • As company gears up, tax shield from interest payments increases the value of the company.
  • At gearing level X, shareholders start to want higher return to compensate for increasing bankruptcy risk and agency.
  • Beyond gearing level Y, tax benefits are more than outweighed by bankruptcy and agency costs and so Y is the optimal level of gearing.

Optimal capital structure

Conclusions:

  • Traditional approach: OCS exists
  • Miller and Modigliani I: no OCS is found
  • Miller and Modigliani II: OCS is 100% debt
  • Market imperfections: OCS exists
  • In practice, rather than one optimal capital structure existing for each firm, a range of optimal capital structures may exist.

A practical view

Essay writing tips: 論文代寫

2015-01-18T20:41:06+00:00 June 26th, 2014|講義|