Modigliani
& Miller without Tax
1. No effect of Gearing
Modigliani
& miller theory says that change in gearing level have no effect on
Weighted cost of capital (WACC), because cheaper cost impact is balance by
increased cost of equity. Equity holder charge higher returns for financial
risk, because financial risk is suffered by equity holder.
2. No Impact on WACC
WACC
of geared and un geared company are same, and gearing has no effect on the WAC.
3. No Change in Market Value
Market
value of Geared and un geared Company is same, we know that market value
depends on the weighted average capital. Due to no change in the WACC, market
value will remain same.
4. Cost of Equity
Cost
of equity increases, and this increase can be expressed by the following
formula;
Cost of Equity (Geared)
=Cost of equity (un) + D/E (Cost of Equity (u)- Cost of Debt)
Keg= Keu + D/Eg (keu-Kd)
