Modigliani

Definition

Modigliani refers to Franco Modigliani, an economist who co-developed the Modigliani-Miller theorem. This theorem is foundational in understanding capital structure in corporate finance.

5 Must Know Facts For Your Next Test

1. The Modigliani-Miller theorem states that, under certain conditions, the value of a firm is unaffected by its capital structure.
2. It assumes no taxes, no bankruptcy costs, and efficient markets.
3. Franco Modigliani won the Nobel Prize in Economics in 1985 for his contributions to financial economics.
4. The theorem has two propositions: Proposition I (irrelevance proposition) and Proposition II (the cost of equity increases with leverage).
5. Real-world deviations from Modigliani-Miller assumptions include taxes and bankruptcy costs.

Review Questions

• What are the key assumptions behind the Modigliani-Miller theorem?
• What is the primary assertion of Proposition I in the Modigliani-Miller theorem?
• How does Proposition II of the Modigliani-Miller theorem relate to a firm's cost of equity?

Related terms

Capital Structure:

The mix of debt and equity financing used by a firm.

Leverage:

The use of borrowed money to amplify returns from an investment or project.

Efficient Markets Hypothesis (EMH): A theory stating that asset prices fully reflect all available information.