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					CAPITAL STRUCTURE THEORIES
There are varying opinion as to whether Financing Mix impacts firm
Value. There are three theories we will look at each saying something
different. We will look at a hypothesis also

A. Traditional Approach
B. Net Income Approach
C. Net Operating Income Approach
And
Modagliani Miller Hypothesis.

BASIC QUESTION: CAN FIRM VALUE BE ALTERED BY JUST ALTERING
FINANCING MIX

A. Traditional Approach: YES, Firm value can be impacted by just altering
the financing mix of the firm. At the Optimum mix of Debt and Equity the
WACC is the lowest, When WACC is lowest firm value is Highest.

B. Net Income Approach: YES, Firm value can be impacted by just
altering the financing mix of the firm. Since Debt is cheaper than equity and
interest paid is a tax deductable expense. A 100% Debt is the optimal
Financing Mix . Then the firm value is highest.

C. Net Operating Income Approach: NO, Financing mix has no impact on
firm Value. The Market capatlises the Firm as a whole, if the cash flow prospect
and the risk of the business does not change mearly changing how the business
is funded will have no impact on value.

Modagliani Miller Hypothesis.
           M and M are considered the Father of Corporate Finance. The birth
of Corporate Finance can be traced back to an article they wrote in an American
Journal on Economics way back in 1957. They won the Nobel Prize for they work
on Corporate Finance. They argue on Behalf of Net Operating Income Approach
They say

             Two firms with identical cash flows and prospects will not be valued
differently in the market just because of the way they are funded. The law of one
price will see to it that investors will observe this price difference and will buy
the cheaper company shares and sell the more expensive company shares
( arbitrage) and drive the prices to equilibrium. Thus in a market of informed
investors, where information is costless, there are no transaction cost and there
is no income tax Capital Structure has no impact on Firm Value.

				
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