INTRODUCTION

A firm's financial or capital structure is a composition of its liabilities. More precisely, it refers to the way in which the financing of the firm takes place through a combination of debt and equity. In order to determine the value of a firm, it is necessary to evaluate the inflows and outflows over time. The Modigliani–Miller (1958, 1961, 1963) theorem is concerned with the process of determination of the value of a firm. No single result has been more important than the Modigliani–Miller theorem of capital structure in the development of the field of corporate finance. The theorem says that if the capital market is perfect, then the value of a firm is independent of the method by which a firm finances its asset. This result forms the basis for examining the reason why in reality the method of financing or capital structure may affect a firm's value. It can be useful to investigate in what respects actual valuation may deviate from the valuation that arises when the method of financing is assumed to be irrelevant. We, therefore, analyze the Modigliani-Miller theorem in Section 6.2 of this chapter. Section 6.3 provides a discussion on the assumptions of the theorem.