Proving Modigliani and Miller Theories of Capital Structure: The Research on Indonesia’s Cigarette Companies

7th International Academic Conference, The International Institute of Social and Economic Sciences (IISES), Prague, Czech Republic

20 Pages Posted: 10 Jun 2019 Last revised: 30 Jan 2021

See all articles by Galuh Adika Alifani

Galuh Adika Alifani

University of Cambridge, Judge Business School; Bandung Institute of Technology; The Boston Consulting Group - Jakarta

Anggoro Budi Nugroho

Universite de Limoges LAPE PhD, France; School of Business and Management, Bandung Institute of Technology

Date Written: May 23, 2013

Abstract

Modigliani and Miller theories, held as one of the most important theoretical compass for the world of Corporate Finance, has stated some aspects and measurements in which will determine one company’s step of heading towards financial decision of its capital structure. Modigliani and Miller themselves are revising their theorem until they created the second theorem of Modigliani and Miller, and also developing their theorem with the assumption of the existence of taxes, in which in the real world, we can’t deny that it exist. This paper is going to review and re-prove the MM theories in a research of three biggest public listed cigarette companies in Indonesia. Those companies are PT. Hanjaya Mandala Sampoerna Tbk., PT. Bentoel Internasional Investama Tbk., and PT. Gudang Garam Tbk. The analysis would be through the companies’ financial statement from the last 10 years, presented in a yearly basis of period. The reports are going to be compared with the two theorems made by Modigliani and Miller, both with and without tax assumption. As the result, it can be concluded whether the MM theorem works and is relevant for those three companies named above. By using the valuation and capital structure approach with several assumptions necessary to be made, the author has found out that the Modigliani Miller theories of capital structure do hold and are accurate for those given sample companies in representative to an industry. However, given different approach of measuring the cost of equity capital, the author found out that Modigliani Miller theories cannot adapt the cost of capital approach, but instead, go in line with the return on equity approach. Because of that, in some explanations of Modigliani Miller theories, the term cost of capital should not be written in the formulas, but instead, it should be written as the return on equity. The author also found some difference in calculation result between the research calculations and the MM theories, which is that the return on equity decreases as the leverage increase, while the MM theory stated that the return on equity should increase as the leverage increase, but that difference does not violate the theories, and they generally are still hold and valid. This happens because those factors have already been addressed as an exceptional condition in the MM theory, and it proves to be true that it has to be exceptional. Finally, the author addressed and concluded the factors that may lead inaccuracy in making calculations based on the MM theories, and the important assumptions to remember within this theory.

Keywords: Capital Structure, Corporate Finance, Financial Analysis, Debt/Equity Ratio, Company Performance, Modigliani Miller, Company Valuation, Cost of Capital, Cost of Equity, Return on Equity, Optimal Capital Structure

Suggested Citation

Alifani, Galuh Adika and Nugroho, Anggoro Budi, Proving Modigliani and Miller Theories of Capital Structure: The Research on Indonesia’s Cigarette Companies (May 23, 2013). 7th International Academic Conference, The International Institute of Social and Economic Sciences (IISES), Prague, Czech Republic, Available at SSRN: https://ssrn.com/abstract=3393045 or http://dx.doi.org/10.2139/ssrn.3393045

Galuh Adika Alifani

University of Cambridge, Judge Business School ( email )

Trinity Ln
Cambridge, CB2 1TN
United Kingdom

Bandung Institute of Technology ( email )

Dep of IE, Gedung Labtek III
Ganesha 10
Bandung, West Java 40132
Indonesia

The Boston Consulting Group - Jakarta ( email )

J.F. Kennedylaan 100
3741 EH Baarn
United States

Anggoro Budi Nugroho (Contact Author)

Universite de Limoges LAPE PhD, France ( email )

5 rue Félix Eboué BP3127
LIMOGES, 87031
France

School of Business and Management, Bandung Institute of Technology ( email )

Dep of IE, Gedung Labtek III
Ganesha 10
Bandung, West Java 40132
Indonesia

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