Assumption of MM theory

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This topic contains 4 replies, has 2 voices, and was last updated by  koolliver 3 years ago. This post has been viewed 46 times

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• #46153

koolliver
Participant

there is an assumption in MM theory , Debt is perpetual and irredeemable.
it is written is an unrealistic assumption. kindly explain how it is unrealistic and if this assumption is removed from MM theory ,, how it is going to change the theory?

Secondly if we want to value a company, ( VALUATION).,, if growth of dividends is greater than Ke we cant use DVM , then how will we value such a a company ?? is there any modification to DVM ?

#71218

John Moffat
Keymaster

Irredeemable debt does not really exist in real life, because lenders would not lend money if they were never going to get repaid.
This is one reason why M7M theory is not ‘perfect’, however if we assume that as redeemable debt is repaid then new debt is issued to finance the repayment it effectively makes it irredeemable (although still not perfect because interest rates are likely to be different).

DVM does work for companies with dividend growth rate higher than Ke, and for this reason is only really suitable for large mature companies with a sustainable growth rate. There is no modification to DVM.

#71219

koolliver
Participant

thanks, but If g is greater than Ke,
in DVM formula when we deduct g from ke ( Ke-g) it will become a negative number. how can we solve it if we have a negative number ?

#71220

John Moffat
Keymaster

I am sorry – I realise that there was a typing error in my previous reply ((

It should have read DVM does NOT work for companies with dividend growth higher than ke (or for companies that pay no dividends). For this reason it is only regarded as being suitable for large mature companies with a sustainable dividend growth rate.

#71221

koolliver
Participant

thank you and no problem for your typing mistake.

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