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The Modigliani-Miller Theorem with Financial Intermediation
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Abstract
This paper shows that, if firms borrow at an interest rate that is greater than the rate at which they can lend, the value of a firm declines with the amount borrowed. The model assumes the possibility that a firm may go bankrupt, which introduces the need for financial intermediation. A modified version of the homemade lev-erage examples introduced by Modigliani and Miller [2] is used to introduce the concept. A state-preference model is used for a more formal proof.
KeywordsModigliani-Miller TheoremFinancial IntermediationValuation
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