- This topic has 3 replies, 2 voices, and was last updated 6 months ago by John Moffat.
- May 9, 2020 at 8:56 am #570387confideans
(A) Many tax jurisdictions worldwide allow debt interest to be deducted from profits before the amount of tax payable is calculated on the profits. Increasing the amount of debt finance will increase the amount of interest paid, reducing the taxable profits and therefore the tax paid. Modigliani and Miller referred to this as the benefit of the tax shield in their research into capital structure, where their amended capital proposition demonstrated the reduction in the cost of capital and increase in the value of the firm, as the proportion of debt in the capital structure increases.
Question ) what is their amended capital proposition? I am confused because of the “amended capital” part. I know their proposition 1 and 2 according to your lecture.
Thank you.May 9, 2020 at 5:07 pm #570429John MoffatKeymaster
The amended proposition is the introduction of corporate tax (at first they ignored corporate tax).
With tax, the WACC will reduce and therefore the value of the firm will increase as I explain in the lectures.May 10, 2020 at 7:57 am #570455confideans
I see so, their amended capital structure proposition refers to the M&M proposition 2.May 10, 2020 at 8:50 am #570459John MoffatKeymaster
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