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Modigliani and Miller Propositions with Financial Formulas

1. Compare and contrast the Modigliani and Miller propositions with the Weighted Average Cost of Capital (WACC) approach.
2. According to the textbook author (find reference below), what is a puppeteer? Are puppeteers important to the financial process? Are puppeteers functioning in a good or evil manner? Justify your response.
3. Describe the major capital structure changes that happened to IBM. Which of these structure changes were the most beneficial to the company? What were the major liability categories for IBM, particularly between 2001 and 2003? Substantiate your response.
4. Financial formulas are used to compute the explicit tax-value consequences for different leverage structures. The most widely used formulas are the adjusted present value (APV) and the tax-adjusted weighted average cost of capital (WACC) formulas. Which formula is the best to use under various situations? Provide some examples to justify your response.

Textbook: Welch, I. (2009). Corporate finance: An introduction. Upper Saddle River, NJ: Prentice Hall.

Please cite other references. Thanks for your help.

Solution Preview

1. The Modigliani and Miller theory is essentially a theoretical perspective that proposes that there is no correspondence or absolute connection between the manner in which an organization finances its operations, or receives its initial financing, and the subsequent financial value of that given firm. In essence, the value of a firm is based upon its efficiency and effectiveness within a given market, as well as its ability to function under the various internal and external conditions that are commensurate with economic conditions at any given time. Due to this factor, if an organization is financed through the use of capital firm investors, or if this organization is financed through the selling of shares of stock, there will be no significant and appreciable differential in the subsequent value of that particular firm (Welch, 2009). This theory contrasts with the weighted average cost of capital approach, due to the fact that the weighted average cost of capital approach presupposes that an organization must earn a certain amount of profit on its holdings and or assets in order to keep investors satisfied with their investment decision. In addition, there is an absolute minimum that an organization can profit on its holdings or assets, and maintain the satisfaction of investors as well as creditors in many respects. In essence, if the organization does not perform up to par in respect to profitability that is satisfactory to its investors etc., then this theory advocates that these investors would discontinue their investments and or the maintenance of their holdings with ...