CAPITAL STRUCTURE

WORLD WITHOUT TAXES

Firm NO debt Firm WITH debt

FORMULA
1) MM PROPOSITION I
V=B+S (firm's value) VL= Vu
V = EBIT
Ro

V = EBIT
Rwacc

Firm value does not affected by leverage

2) MM PROPOSITION II

a) RS (Cost of equity, rate of return to equityholders) RS = Ro + B (Ro – Rb)

RS = Ro S

Rs is positively related to leverage because risk increases with leverage

b) Rwacc = Ro Rwacc = Ro
OR
Cost of capital, weighted average cost of capital, Rwacc = B (Rb) + S (Rs)
overall cost of capital)
V V
OR
Rwacc = EBIT
V
Rwacc is always equal to Ro regardless its capital structure in a world without taxes