Generalization of the Modigliani–Miller Theory for the Case of Variable Profit

Peter Brusov, Tatiana Filatova, Natali Orekhova, Veniamin Kulik, She-I Chang and George Lin
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Tatiana Filatova: Department of Financial and Investment Management, Financial University under the Government of Russian Federation, 117198 Moscow, Russia
Natali Orekhova: High Business School, Southern Federal University, 344090 Rostov-on-Don, Russia
Veniamin Kulik: Deutsche Bank Ltd., 117198 Moscow, Russia
She-I Chang: College of Management, National Chung Cheng University, Jiayi City 60078, Taiwan
George Lin: College of Management, National Chung Cheng University, Jiayi City 60078, Taiwan

Mathematics, 2021, vol. 9, issue 11, 1-24

Abstract: For the first time we have generalized the world-famous theory by Nobel Prize winners Modigliani and Miller for the case of variable profit, which significantly extends the application of the theory in practice, specifically in business valuation, ratings, corporate finance, etc. We demonstrate that all the theorems, statements and formulae of Modigliani and Miller are changed significantly. We combine theoretical and numerical (by MS Excel) considerations. The following results are obtained: (1) Discount rate for leverage company changes from the weighted average cost of capital, WACC, to WACC–g (where g is growing rate), for a financially independent company from k 0 to k 0 –g. This means that WACC and k 0 are no longer the discount rates as it takes place in case of classical Modigliani–Miller theory with constant profit. WACC grows with g, while real discount rates WACC–g and k 0 –g decrease with g. This leads to an increase of company capitalization with g. (2) The tilt angle of the equity cost k e (L) grows with g. This should change the dividend policy of the company, because the economically justified value of dividends is equal to equity cost. (3) A qualitatively new effect in corporate finance has been discovered: at rate g < g* the slope of the curve k e (L) turns out to be negative, which could significantly alter the principles of the company’s dividend policy.

Keywords: generalization of Modigliani and Miller theory; variable profit; company capitalization; equity cost; the weighted average cost of capital; WACC (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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