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Abstract
Modigliani and Miller's argument of the irrelevance of the debt-equity ratio to the value
of the firm implies that capital structure has no impact on the value of the firm (irrelevance result).
In the existing work, the proof or disproof of the Modigliani and Miller theorem is based critically on some specific assumptions,
not general enough to be always valid in practical finance, and
including especially a constant interest rate for borrowing.
This paper develops another optimal financing model, whose assumptions differ from those in previous models for the Modigliani and Miller theorem.
If the borrowing rate
increases with the amount
borrowed, there is a unique optimal ratio of debt to equity,
determining the optimal capital structure.
Therefore the debt-equity
ratio does affect the value of the firm, and hence the need for good corporate financial management
to maximize the value of the firm, by choosing the optimal debt.
Some important issues of sensitivity are also analysed.
The proposed model should apply to more real situations, and therefore makes an
original contribution to finance.
Mathematics Subject Classification: 91G50.
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