First, the theoretical meaning of MM
The original MM theory holds that the company's market value has nothing to do with the company's capital structure without considering the enterprise income tax and the same business risk.
In other words, when the company's debt ratio increases from zero to 100%, the total cost and total value of the enterprise will not change, that is, the enterprise value has nothing to do with whether the enterprise is in debt or not, and there is no optimal capital structure problem.
The modified MM theory holds that considering the enterprise income tax, the comprehensive capital cost can be reduced and the enterprise value can be increased because the debt interest is tax-free expenditure. Therefore, as long as the company continuously reduces its capital cost through increasing financial leverage, the more liabilities, the more obvious leverage and the greater the company value.
When the debt capital is close to 100% in the capital structure, it is the best capital structure. At this time, the enterprise value reaches the maximum. The original MM theory and the modified MM theory are two extreme views on debt distribution in the capital structure theory.
Second, the basic assumptions of MM theory?
The business risk of an enterprise is measurable, that is, enterprises with the same business risk are at the same risk level; The current and future investors' estimates of the future EBIT of the enterprise are completely consistent, that is, the investors' expectations of the future benefits of the enterprise are consistent with the risks they face in obtaining these benefits; The securities market is perfect and there is no transaction cost; Investors can get loans at the same interest rate as companies. ?
No matter how much you borrow, the liabilities of companies and individuals are risk-free, so the interest rate of liabilities is risk-free; The investor's expected EBIT remains unchanged, that is, assuming the growth rate of the enterprise is zero, then all cash flows are annuities; The company's dividend policy has nothing to do with the company's value, and the company's issuance of new debts does not affect the market value of existing debts.
Two types of MM theory?
First, MM model without corporate tax.
MM theory points out that the total risk of all securities holders of a company will not change because of the change of capital structure. Therefore, regardless of the company's financing portfolio, the total value of the company must be the same.
The existence of arbitrage in capital market is an important support for this hypothesis. Arbitrage avoids the different prices of perfect substitutes in the same market. Complete substitution refers to two or more companies with the same risk but different capital structures. MM theory holds that the total value of such companies should be equal.
According to MM theory without corporate tax, corporate value has nothing to do with corporate capital structure. In other words, whether the company has liabilities or not, the weighted average cost of capital of the company is unchanged.
Secondly, MM model with corporate tax.
MM theory holds that when there is corporate tax, the advantage of borrowing is that debt interest payment can be used to offset the tax, so financial leverage reduces the weighted average cost of capital after tax.
The present value of tax avoidance income can be expressed by the formula: present value of tax avoidance income =tc*r*B/r=tc*B, where tc is the corporate tax rate; R is the debt interest rate; B is the market value of debt. Therefore, the more debt the company has, the greater the tax avoidance income and the greater the company value.
After adding corporate tax to the original MM model, it can be concluded that the existence of tax is an important manifestation of the imperfection of the capital market. When the capital market is imperfect, the change of capital structure will affect the value of the company.
In other words, the company's value and capital cost change with the change of capital structure. The value of leveraged companies will exceed that of non-leveraged companies (that is, the value of indebted companies will exceed that of non-indebted companies). The more debt, the greater the difference. When the debt reaches 65,438+000%, the company's value will be the largest.