CHALLENGE
TO
MODIGLIANI
AND
MILLER
MODEL |
|
|
|
|
Frequently Asked Questions
|
|
|
What it means that the company geared through 100% financing will have no value in actual terms? For Example what will be the value of Total Assets of USD 50,000 financed as follows?
|
| Value of Equity (Shares) | 25,000 |
| Value of Loans | 25,000 |
| Total Assets | 50,000 |
Ans:
Theory already has proved that the value of business for shareholders will be NIL in the real term because any prospective buyer of a above 100% geared company will buy the equity shares for USD 25,000 and at the same time accepting the liability of USD 25,000.
Therefore the net value for investor will be as follows:
|
|
| Purchase Value of Equity Shares | 25,000 |
| Value of Loans accepted along with Shares | (25,000) |
| Net value of shares | NIL |
|
The value of total assets of the company is USD 50,000 than how can it be accepted that value of share will be nil in 100% Geared company
Ans:
Operational Value of any business is independent of gearing level, depending upon the expectations of investors. For example in above illustration total value of company is USD50,000 distributable to Equity Holders and to Loan providers.
If value of Assets goes down say by 1,000 due to any reason it will not affect loan amount on company but it will directly reduce the equity by same amount, which means that if value of assets went down by USD 25,000; it will not affect Loans payable by company. It Cleary shows that risk of loss of Loan providers will starts after swallowing the value of equity. Hence we can say that total Assets purchased will be used for the payment of Debts and in case of any surplus than distribution to equity holder will be made. Therefore, it will not be wrong to say that in 100% Geared Company, the value of Loan is double the actual loan amount invested. Hence statutory rights of the human being got affected with this risk discrimination.
|
Should we take the meaning that it is in loss to boost up the business while gearing up our company's capital structure?
Ans:
If any company has taken loans, it should return its loans as early as possible, as the portion of the loan is paid back the value of the company will increase with the same proportion. Company value will be raised in the same proportion the loan got paid.
In other words, if someone wants to boost up its business while taking the risk of Loan at fixed rate of interest with the intentions to paid back of loan from Re will be in a better position than the investor who is taking loan for long term basis.
|
If it is at loss to run a geared company than, why millions of the people around the world are getting loans to run there operations at high level?
Ans:
While operating profits are high and distributions to the loan providers and to the equity holders is high in terms of money. So currently what owners of the geared company are earning is major for the Loan providers not for equity holders in long run. Point is to be noted that Banks are now a days willing to give 70% of total value of investment to earn there profits with out putting any efforts in the business, reason behind is that the day Bank puts its 70% its value will become 100% because assets purchased with the total capital will be for the bank. For details please go to the answers of Q # 1 & Q # 2.
|
|
