MM capital structure calculations - part 1

In this lesson

1. 0:00 Miller and Modigliani capital structure overview
2. 2:00 The with tax model and geared firm value
3. 3:11 Calculating firm value with debt example
4. 5:45 Cost of equity in geared companies formula
5. 7:47 Working out cost of equity calculation
6. 10:14 Understanding risk and equity returns

About this lesson

These formulas appear across CIMA and ACCA papers including FM, AFM, and SBL, and whilst they look complex, the calculations themselves are straightforward once you grasp the mechanics. We start with a recap of MM's 1963 with-tax model, which shows that increasing gearing lowers the weighted average cost of capital because interest is tax deductible. You'll then work through the first two formulas: the value of a geared firm (VG = VU + tB) and the cost of equity in a geared company. Both are explored step-by-step using a practical example comparing an unlevered firm with an identical geared firm, so you see exactly how debt increases company value and raises equity investor returns. By the end, you'll understand why geared firms are worth more than ungeared ones in this theoretical model, how to calculate that value difference, and why equity holders demand higher returns when their company takes on debt. This foundation prepares you for part two and equips you to handle capital structure questions with confidence.

Duration: 11m