QUESTION 1

Theoretically Modigliani and Miller (1958) took a fairly straightforward view of the purpose of a company in an economy. They pointed out that companies take cash from providers of long-term funds, invest it in new projects with positive Net Present Value (NPV) and repay the future net inflows to these fund providers in the form of dividend plus interest. They showed that there is no relationship between debt and the value of the firm and it seems to be good enough in the light of the assumptions underlying their model. However, most of these assumptions are unrealistic and untenable.

Required

Explain the validity of the Modigliani and Miller (1958) model in the real world along with their assumptions

QUESTION 2

"The agency theory concept was initially developed by Berle and Means (1932), who argued that due to a continuous dilution of equity ownership of large corporations, ownership and control become more and more separated. This situation gives professional managers an opportunity to pursue their own interest instead of that of shareholders. Major effort of researchers has been devoted to models in which capital structure is determined by agency costs".

Required

Discuss in relation to the Agency problem by Jensen and Meckling (1976)