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Influence Of Debt Financing On The Effectiveness Of The Investment Project Within The Modigliani–Miller Theory

Peter N. Brusov, Tatiana Filatova, Natali Orehova, Pavel Brusov, Nastia Brusova

Open publisher page 43 citations

Abstract

We study the problem of the influence of debt financing on the effectiveness of the investment project within the theory of Modigliani–Miller and obtain quantitative results for the first time. The effectiveness of the investment project is considered from two perspectives: the owners of equity and debt and equity holders only. It was shown, that  NPV  practically always decreases with leverage in case of a constant value of equity, and the maximum leverage level, at which the project is still effective ( NPV> 0), was found. In case of a constant value of the total invested capital it is possible an increase of  NPV  with leverage as well as its decrease, depending on the relation between the parameters of the project.

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What this paper is about

We study the problem of the influence of debt financing on the effectiveness of the investment project within the theory of Modigliani–Miller and obtain quantitative results for the first time. The effectiveness of the investment project is considered from two perspectives: the owners of equity and debt and equity holders only. It was shown, that  NPV  practically always decreases with leverage in case of a constant value of equity, and the maximum leverage level, at which the project is still effective ( NPV> 0), was found. In case of a constant value of the total invested capital it is possible an increase of  NPV  with leverage as well as its decrease, depending on the relation between the parameters of the project.

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Available abstract

We study the problem of the influence of debt financing on the effectiveness of the investment project within the theory of Modigliani–Miller and obtain quantitative results for the first time. The effectiveness of the investment project is considered from two perspectives: the owners of equity and debt and equity holders only. It was shown, that  NPV  practically always decreases with leverage in case of a constant value of equity, and the maximum leverage level, at which the project is still effective ( NPV> 0), was found. In case of a constant value of the total invested capital it is possible an increase of  NPV  with leverage as well as its decrease, depending on the relation between the parameters of the project.

Key concepts: Leverage (statistics), Debt, Capital structure, Miller, Economics, Gearing ratio, Equity value, Debt financing

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