This Approach was developed by Prof Franco Modigliani

and Mertan Miller in their classic contribution on CS

which has been called the most influential finance article
ever written who become Nobel Laureates in economics.
MM Approach is identical to the NOI Approach.
It supports the NOI Approach relating to the
independence of the cost of capital of the degree of
leverage at any level of debt equity ratio.
It argues that the value of the firm is independent of
its capital structure.
The difference b/w NOI Approach and MM approach
is that NOI Approach is more definitional or
conceptual and lacks behavioral significance.
However the MM Approach, provides behavioral
justification for constant overall cost of capital and
therefore, total value of the firm.
Basic Proposition
The overall cost of capital [Ko] and the value of the
firm [V] are independent of its capital structure. the
Ko and V are constant for all degrees of leverage. The
total value of the firm is given by capitalizing the
expected stream of operating earnings at a discount
rate appropriate for its risk class.
Assumptions
1. Perfect Capital Markets-
I. securities are infinitely divisible,
II investors are free to sell / buy securities,
III investors can borrow w/o any restriction on
the same terms and conditions as firms can
IV there are no transaction costs
V information is perfect
VI investors are rational and behave accordingly.
2. All investors expect the same EBIT which is used to
evaluate the value of the firm
3.all firms belong to homogenous risk class
4. the dividend pay out ratio is 100%
5. there are no taxes. This assumption is removed
later.
Based on the above set of assumptions MM propose
that the overall costs of capital Ko and the value of
the firm V are independent of C.S.
K & V are constant for any proportion of debt equity
mix.
The operational justification for the MM hypothesis is
the ARBITRAGE PROCESS
MM prove this proposition on the basis of arbitrage
process.
Arbitrage refers to the act of buying an asset or
security in one market at lower price and selling it in
another market at higher price.
Arbitrage process is a balancing operation
MM pointed out that in a perfect market ,minor
variations would be ironed out by continuous
speculative activities taking place in the market.
If for a moment, the share price of Co.A goes up,
immediately a series of speculative transactions would
take place and iron out the momentary rise in the
price of Co. A.
Corporate leverage & personal leverage are
substitutable.
MM argue that the advantages of borrowing can be
derived by individual investor by going for similar
borrowings at his own level.
Hence, this makes borrowing policies of corporation
irrelevant on individual investor and market.