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# Capital structure: Modigliani/Miller propositions

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Using the Modigliani/Miller propositions with taxes, calculate the change in the value of the firm and the change in the required return on equity if it borrows \$2,000,000 and uses the funds to retire \$2,000,000 of its equity. The cost of the debt will be 8% and the current required return on equity is 14%. Currently, the firm has 3,000,000 shares outstanding and they are selling for \$4.00 each and no debt. The corporate tax rate is 40%.

#### Solution Summary

This solution is to find out Value of a unlevered firm after debt is introduced to retire portion of equity. Here the cost of equity is recalculated.

\$2.19
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## Capital Structure Policy: Theory and Practice of the Modigliani and Miller models of capital structure

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Explain the Modigliani and Miller models of capital structure both with and without corporate income taxes.

Specifically, explain the relationship between debt leverage and the value of the firm and between debt leverage and the cost of capital.

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