MM Hypothesis for capital structure is based on which of the following assumptions?

(a) Investors are rational and have homogeneous expectations

(b) Perfect capital market

(c) 100% retention of profits

(d) No taxes

Which of the following options is most appropriate ?

Question

Question

This question was previously asked in

UGC NET Paper 2: Management 24th June 2019 Shift 2

Answer 1

The correct answer is (a), (b), (d)

Key Points

Capital Structure: It refers to the specific ratio of debt to equity that is used by an organization to fund the all aspects of business operations and its expansion.
MM (Modigliani Miller) hypothesis shows that a company's capital structure is unrelated to a firm's valuation, which means the market value of a company is unaffected by the amount of debt it carries.

Important Points

There are various assumptions of MM Hypothesis under capital structure:

Investors are rational.
All firms' predicted earnings have the same risk characteristics.
Investors have homogeneous expectations.
There is no transportation cost with regard to sale/ purchase of securities.
There is perfect capital market, i.e. investors are totally free to buy/ sell the securities.
At first, MM hypothesis presupposed that no corporate tax is paid; however, they eventually abolished this presumption.
No retained earnings, i.e. 100% Distribution to shareholders.
Symmetry of information is present there .

Hence, the correct answer is (a), (b), (d)