The basic idea of capital structure in a perfect market is the choice of debt or equity financing will not affect the total value of a firm, its share price, or its cost of capital. As a result, firms and their stockholders are indifferent to choice of financing - Equity or Debt.
Here the theory of Modigliani-Miller on Leverage, Arbitrage, and Firm Value is of importance.
The key idea is leverage (use of debt as well as equity to finance firm) affects who gets the firm’s cash flows but not the cash flows themselves.
Perfect markets are :
1) Investors and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows.
2) There are no taxes, transaction costs, or issuance costs associated with security trading.
3) A firm’s financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them.
MM Proposition I: In a perfect capital market, the total value of a firm is equal to the market value of the total cash flows generated by its assets and is not affected by its choice of capital structure.
MM and the Law of One Price :
1) the total cash paid to a firm’s investors (debt and equity) equals the total cash generated by the firm’s assets.
2) by the Law of One Price, the firm’s debt and equity must have same value as the firm’s assets.
3) by assumption, capital structure has no impact on the total cash flow generated by firm’s assets - a change in capital structure has no impact on the combined value of the firm’s stock and bonds Note: capital structure decisions only affect who gets the firm’s cash flows.
The value of a levered firm differing from an otherwise equivalent un-levered firm creates an arbitrage opportunity
Identify a market that enjoys perfect, or nearly perfect, competition. How do the competitors interact with each other and suppliers and customers?
Identify a market that enjoys perfect, or nearly perfect, competition. How do the competitors interact with each other and suppliers and customers?
how do regular dividends policies function in both perfect and imperfect capital markets? And how do companies select the best dividend policy for there company?
Perfect competition is considered to be the most efficient market structure. In a short essay (3 paragraphs), using a graph or two, explain this concept fully. How do Imperfect markets cost society? What is lost? Be specific, define your terms, and give examples.
Which of the following is CORRECT about M&M theory on capital structure? A) In a perfect MM world, capital structure does not matter for equity risk. B) In a perfect MM world, higher leverage leads to a higher firm value. C) In a MM world with only corporate tax, capital structure does not matter for equity risk. D) In a MM world with only corporate tax, higher leverage leads to a higher firm value.
Market Structure broadly of 4 types : 1.Perfect Competition : Where there are large number of buyesrs and sellers. No individual firm has control over prices of goods and services. Optimum price and quantuquis determined based on market forces and hence, the output, thus produced is socially optimum. This type of market structure is very hard to find in real world. Kne close example would be Stock Market. 2. Monopoly : A type of market structure where a single seller...
Which of the following is not a type of market structure? A. monopolistic competition. B. perfect competition. C. monopolistic oligopoly. D. monopoly
In a perfect capital market, leverage will increase the cost of levered equity only if the debt is not risk free True or false
A characteristic of perfect competition that is not present in any other market structure is that there 1are many sellers and each produces its own version of the product. 2are a small number of sellers and at least a few of them have market power. 3is only one seller and that seller holds a high level of market power. 4are many sellers that produce identical products.
(a) Which market structure, Perfect Competition, Monopoly, or Monopolistic competition, will result in the greatest degree of choice between alternate products for consumers? Please give an explanation. (b) In which market structure are firms most likely to advertise? Please explain.