1In their first model do Modigliani Miller believe that cap

1-In their first model, do Modigliani & Miller believe that capital structure affects firm valuation? How about in their second model? Explain what causes the difference between these two conclusions.

2. What does IPO underpricing refer to? When in recent decades has it been most severe? What are some reasons that underwriters might want to underprice their IPOs? On the other hand, what might be some problems with this approach?

3. What is venture capital? If you were a venture capitalist, what are some of the things you would be looking for in potential investments? If you were a company looking to get venture capitalists to invest in you, what are some of the things you would consider when choosing among competing venture capital firms?

Solution

(1) In their first model, Modigliani and Miller (MM) ignore a variety of costs, the most important among them being tax liabilities of a firm. In the absence of tax liability, the value of an unlevered and levered firm will be equal as per MM, thereby implying the irrelevance of firm\'s capital structure in the context of the firm\'s value. As per the first model, firm value is solely generated by a firm\'s earnings/cash flows.

In the second model, MM do not ignore taxes which implies that a firm\'s value is impacted by the benefits of interest tax shields. In other words, a firm with debt enjoys tax exemption on its interest expenses, thereby being a source of value to the firm. Hence, firms with greater debts will enjoy greater interest tax shield benefits and the same along with the firm\'s earnings/cash flows will determine its overall value. This means that a firm\'s capital structure plays a role in determining its value.

NOTE: Please raise separate queries for solutions to the remaining unrelated questions.