Modigliani-Miller (M&M) propositions
Principles of Finance glossary · Time Value of Money
Definition
The foundational theorems (Modigliani-Miller 1958, 1961) establishing that in a frictionless market - no taxes, no bankruptcy costs, no asymmetric information, no transaction costs - firm value is independent of capital structure (Proposition I) and dividend policy. Proposition II states that the cost of equity rises linearly with the debt-to-equity ratio, leaving WACC unchanged. With corporate taxes, the tax shield makes leverage value-additive, motivating the trade-off theory.
Modigliani-Miller (M&M) propositions in plain English
Imagine two identical pizza shops that earn the exact same profit. One paid for its ovens with a bank loan, the other with the owners' cash. Modigliani and Miller proved that in a perfect, friction-free world, the two shops are worth exactly the same, because how you SPLIT the money you owe (debt vs. owners' stake) doesn't change how much pizza the shop actually sells. Proposition I says total company value doesn't depend on that debt-vs-equity mix; Proposition II adds that if you borrow more, the owners rightly demand a higher return for taking on more risk, so your overall average cost of money stays flat. The catch: real life has taxes, and because interest on loans is tax-deductible, borrowing can genuinely add value, which is why companies use debt at all.
Also called: M&M
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