On the Theoretical Foundation of Corporate Finance

16 Pages Posted: 15 Oct 2020

See all articles by Jing Chen

Jing Chen

University of Northern British Columbia - School of Business

Date Written: August 26, 2020

Abstract

Modigliani and Miller theory forms the theoretical foundation of corporate finance. Yet Modigliani and Miller theory was derived from a very special case of cash flows. Weighted Average Cost of Capital (WACC), which is part of the Modigliani and Miller theory, plays a fundamental role in capital structure decision and asset valuation. In practice, asset valuation calculated from cash flows discounted by WACC almost always differs from the sum of debt and equity values. We derive asset valuations for more general cashflows. Only when the debt equity ratio is constant over time, valuation by WACC is equal to the sum of debt and equity values.

Keywords: WACC, Modigliani and Miller theory, asset valuation

JEL Classification: G12, G30, G32

Suggested Citation

Chen, Jing, On the Theoretical Foundation of Corporate Finance (August 26, 2020). Available at SSRN: https://ssrn.com/abstract=3681470 or http://dx.doi.org/10.2139/ssrn.3681470

Jing Chen (Contact Author)

University of Northern British Columbia - School of Business ( email )

Prince George, BC, V2N 4Z9
Canada
250-960-6480 (Phone)
250-960-5544 (Fax)

HOME PAGE: http://web.unbc.ca/~chenj/

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
21
Abstract Views
99
PlumX Metrics