Gearing up for debt

Theory of finance

The theory of capital structure is often regarded as starting with Modigliani and Miller in 1958. They show that, under certain ‘perfect’ conditions, a firm’s market value is independent of its capital structure. Modigliani and Miller’s assumptions may be unrealistic, but they suggest where to look for relevant ‘imperfections’ (two of which – inflation and tax – stem from governments).

Most textbooks still describe optimal capital structure as a trade-off between the tax benefits of debt and the

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