Lecture 2- Gearing (part 1)

Modigliani-Miller Proposition I (no taxes) states [blank_start]value[blank_end] of [blank_start]levered firm[blank_end] is [blank_start]same[blank_end] as [blank_start]value[blank_end] of [blank_start]unlevered firm[blank_end]

One assumption of Modigliani-Miller Proposition I (no taxes) is [blank_start]individuals[blank_end] can [blank_start]borrow[blank_end] as [blank_start]cheaply[blank_end] as [blank_start]corporations[blank_end]

Another assumption of Modigliani-Miller Proposition I (no taxes) is [blank_start]capital markets[blank_end] are [blank_start]efficient[blank_end]

Third assumption of Modigliani-Miller Proposition I (no taxes) is [blank_start]no taxes[blank_end]

Fourth assumption of Modigliani-Miller Proposition I (no taxes) is [blank_start]no transaction costs[blank_end]

Fifth assumption of Modigliani-Miller Proposition I (no taxes) is [blank_start]no risk[blank_end] of [blank_start]bankruptcy[blank_end]

Homemade leverage is use of [blank_start]personal borrowing[blank_end] to change [blank_start]overall[blank_end] amount of [blank_start]financial leverage[blank_end] to which the [blank_start]individual[blank_end] is exposed

Modigliani-Miller Proposition II (no taxes) states [blank_start]cost of equity[blank_end] [blank_start]rises[blank_end] with [blank_start]leverage[blank_end] because [blank_start]risk to equity[blank_end] [blank_start]rises[blank_end] with [blank_start]leverage[blank_end]

Business risk is [blank_start]equity risk[blank_end] that comes from [blank_start]nature[blank_end] of firm’s [blank_start]operating activities[blank_end]

Financial risk is [blank_start]equity risk[blank_end] that comes from [blank_start]financial policy[blank_end] (capital structure) of [blank_start]firm[blank_end]

Modigliani-Miller Proposition I (with taxes) states [blank_start]value[blank_end] of [blank_start]levered firm[blank_end] is [blank_start]greater than[blank_end] [blank_start]unlevered firm[blank_end] by [blank_start]present value[blank_end] of [blank_start]tax shield[blank_end] from debt

Modigliani-Miller Proposition II (with taxes) states [blank_start]cost of equity[blank_end] [blank_start]rises[blank_end] with [blank_start]leverage[blank_end] because [blank_start]risk[blank_end] to [blank_start]equity rises[blank_end] with [blank_start]leverage[blank_end]