Modigiliani and Miller’s Proposition II, determine the required return on unleveraged equity, assignment help

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Question Description

Using Modigiliani and Miller’s Proposition II, determine the required return on unleveraged equity.

Evaluate why violations of the Modigiliani and Miller assumptions of perfect markets require revisions to your capital budgeting analysis.

Purpose alternative ways in which investors can receive cash returns from their investment in the equity of a company.

Important links to Modigliani YouTubes...Please Watch!!!
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Modigliani Miller Part 1

M&M Propositions I & II with no taxes and no bankruptcy costs

Part 2

Part 3

Tutor Answer

School: Carnegie Mellon University



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In economics there are very many concepts that apply to our day to day activities and
such concepts include the Modigliani and Miller’s propositions which were the basics of capital
structure and up to date they are still used to explain capital structure. From the propositions
developed by these two economists, the company’s value is likely to be unaffected if the
company is not subjected to costs and taxes. Most companies are subjected to taxes but they are
situations when a company is likely to have no debts. The concepts by these two professors were
developed in a world where taxes were not common but they still apply today in our world where
taxes are a must for citizens (Chapman, Hopwood, and Shields, 2007).
Unlevered equity is the equity of a company that is not subject to any debts. It is the
opposite of levered equity which belongs to a company that has debts. To determine unlevered
equity under Modigliani and Miller’s proposition II we use a formula which is as follows. We
form an equation where the rate of return is the subject and it is equal to the required rate of
return on equity or the cost incurred on levered equity. From the equation we get the required
rate of returns and it is equal to unlevered equity plus the financing premium. This is done with
the assumption that all market prices and discounts are applicable to all the stocks.
Violations of the Perfect Market Assumptions
To apply the propositions of this theorem, the perfect market assumptions are important
but at times they are violated (Saltelli, 2004). One thing is that at our current economic status
taxes a...

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