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Irrelevance principle

The text used is Chapter 16 & 17 of:

Berk, J., & DeMarzo, P. (2011). Corporate finance: The Core: 2010 custom edition. (2nd ed.). Boston: Pearson Education.

Thank you.

1. The "irrelevance principle" states that in frictionless markets, capital structure (the mix of debt and equity to finance a firm's assets) doesn't matter. Explain this principle.

2. According to finance theory, in an imperfect market, what are the major advantages and disadvantages of utilizing debt in a firm's capital structure?

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1. The "irrelevance principle" states that in frictionless markets, capital structure (the mix of debt and equity to finance a firm's assets) doesn't matter. Explain this principle.
The principle is that under a certain market price process, if there are no taxes, bankruptcy costs, agency costs, and asymmetrical information and if the market is efficient the value of the firm is unaffected by how it is financed. In other words it does not matter if the firm is financed by equity or by selling bonds. The principle also holds that it does not matter how much dividend the firm pays. In simple terms it means that the capital structure is irrelevant. The irrelevance principle says that the market value of a company is determined by the ...

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