The Pie Again

Although it is comforting to know that the firm might have an optimal capital structure when we take account of such real-world matters as taxes and financial distress costs, it is disquieting to see the elegant original M&M intuition (that is, the no-tax version) fall apart in the face of these matters.

Critics of the M&M theory often say that it fails to hold as soon as we add in real-world issues and that the M&M theory is really just that, a theory that doesn't have much to say about the real world that we live in. In fact, they would argue that it is the M&M theory that is irrelevant, not capital structure. As we discuss next, however, taking that view blinds critics to the real value of the M&M theory.

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