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On the theoretical foundation of corporate finance

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  • Chen, Jing

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. Empirically, 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.

Suggested Citation

  • Chen, Jing, 2021. "On the theoretical foundation of corporate finance," Structural Change and Economic Dynamics, Elsevier, vol. 59(C), pages 256-262.
    • Handle: RePEc:eee:streco:v:59:y:2021:i:c:p:256-262
    DOI: 10.1016/j.strueco.2021.08.012
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    References listed on IDEAS

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    More about this item

    Keywords

    WACC; Modigliani and Miller theory; Asset valuation;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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