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Modigliani-Miller Proof

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Consider a Modigliani-Miller world with no taxes. In this world, consider a firm which
is expected to generate constant cash flows in perpetuity. For this firm VU = VL = D+S
and ks = k0 + (D/S)(k0 - kd). Now, assume that suddenly, a corporate tax at a rate
T is imposed on the firm. Nothing else changes (i.e. the value of debt of the firm and
k stay the same). Show that k does not change. That is, show k(new) = k where k(new) is the value of ks (the required return on equity) in a world with taxes.

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This solution provides a step-by-step explanation of how to calculate the given economics question.

Solution provided by:
Jayant Kumar, MBA
Education
  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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