MM Proposition I The Pie Model

One way to illustrate M&M Proposition I is to imagine two firms that are identical on the left-hand side of the balance sheet. Their assets and operations are exactly the same. The right-hand sides are different because the two firms finance their operations differently. In this case, we can view the capital structure question in terms of a "pie" model. Why we choose this name is apparent from Figure 17.2. Figure 17.2 gives two possible ways of cutting up the pie between the equity slice, E, and the debt slice, D: 40%-60% and 60%-40%. However, the size of the pie in Figure 17.2 is the same for both firms because the value of the assets is the same. This is precisely what M&M Proposition I states: the size of the pie doesn't depend on how it is sliced.

0 0

Post a comment