In financial management, capital structure theory refers to a systematic approach to financing business activities through a combination of equities and liabilities. Thanks for making the concepts so easy. Why Must Marginal Utility be Equal to Price? financial leverage there is NO effect on. Poornima Madushani Patabendige is a finance graduate from the University of Sri Jayewardenepura. There are . This article extends the MM capital structure theorem by relaxing the full payout assumption and introducing retention policy. Such theories include the bird-in-the-hand theory, agency costs theory, signalling . Firms funding requirements are funded through two types of ways. When RK) or 100% (when RK) is zero. It is when there are no taxes. Well informative and i have benefited from this material on my Financial management study. Several theories have been developed to analyse alternative capital structure and explained by academic scholars and researchers in corporate finance. . It includes Equity Share Capital, Reserves and Surplus, Preference Share capital, Loan, Debentures, and other such long-term sources of finance. That is, why should the shareholders worry about maximizing the firm value instead of worrying about maximizing the shareholder value? Capital structure shows the ways and means of financing the fund requirements of an organization and the capital can be funded mainly through two ways. (a) The firm is an all equity firm (no debt). the content was limited and easy to understand. Very helpful.Keep posting. By indicating the conditions under which capital structure is irrelevant, they provided clues . This similarity is due to the similarities of assumptions of both the models. The Dividend Irrelevance Theory argues that the dividend policy of a company is completely irrelevant. Each approach has its own set of advantages and disadvantages. He is passionate about keeping and making things simple and easy. value of firm and overall cost of capital. Her passion for business-related numbers and concepts dragged her into Nerdynaut to share her knowledge and experience across the innovative followers of Nerdynaut. (c) Internal rate of return (R) of the firm remains constant. It ignores the corporate tax and personal taxes that is not practically viable as shareholders pay taxes on the capital gain. The dividend irrelevance theory was developed by Franco Modigliani and Merton Miller in 1961. The growth firms are assumed to have ample profitable investment opportunities. Evidently, capital structure is still an unsettled puzzle and . (b) There is no outside financing and all investments are financed exclusively by retained earnings. Capital structure modern theory starts to be introduced by Modigliani and Miller in 1958 and it also known as MM Irrelevance Theory which was the pioneer capital structure theory (Modigliani and Miller, 1958).