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What is Modigliani- Miller (M and M) approach?
Modigilani-Miller approach is also known as MM approach which looks similar to Net operating income approach. It is in synchronization with the Net operating income approach and states in acceptance with the approach that cost of capital is independent of degree of leverage. It provides justification for operational and behavioural for constant cost of capital at any degree of leverage as this is not being provided by the Net operating Income approach. It is been assumed in this approach that capital markets are perfect and the investors are investing in the company from the same expectation of the company's net operating income in search of evaluating the value of the firm. The propositions of this approach can be mentioned in the following ways and it is as follows:-
1) Company's overall cost of capital and value of the firm is constant at any degree of leverage as it is independent of the capital structure.
2) Capital investment which has the minimum cut-off rate is also independent of project finances.
If this approach has advantages then it has certain limitations associated with it and the limitations are as follows:-
1) Investors find the leverages inconvenient and risk perception of corporate and personal leverage is different.
2) Corporate doesn't exist but it gets removed later.
3) Arbitrary process doesn't have any restrictions and it is also not be affected by transaction cost.
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