Modigliani and Miller Proposition (version 2)

Version 1 of the M&M proposition implies that given a set of assumptions (i.e., conditions) capital structure does not matter (i.e., it is irrelevant).

Their proof follows a basic "If A then B" logic. The true importance of the M&M proposition is revealed when we realize that "If not B, then not A" is the logical equivalent to their argument.

If:

• The market value of the firm is dependent on the choice of financing, or put another way,
• The current choice of financing policy does affect the value of the firm, or put another way,
• There is a unique capital structure which maximizes firm value.

Then it can only do so because at least one of the following is true:

• The choice of firm financial policy affects the firm's tax liability
• The choice of firm financial policy affects the firm's contracting costs
• The choice of firm financial policy affects the firm's choice of future real investment policy