RESCUE PLAN - 2

SRI NOVA ADHI DHEA – 29118073 Modiglani

Modiglani &
& Miller
Miller
Gordon
Gordon &
& Litner
Litner
Majluf
Majluf
 Modigliani & Miller
Irrelevance Theory (Leverage and Profitability)

“Capital Structure is not relevant and

doesn’t affect Firm’s Value”

PREPOSITION I – WITHOUT TAXES

The value of a company that use debt is equal to the value of a company that i
s not in debt. changes in capital structure do not affect company value and the
company's weighted average cost of capital (WACC) will remain the same not
affected by how the company combines debt and capital to finance the
company.

PREPOSITION II – WITHOUT TAXES

The cost of equity will increase if the company carries out or
seeks external loans.
 PREPOSITION I – WITH TAXES
01 financing with debt is very profitable and MM states that the optimal capital structure
of the company is one hundred percent debt

PREPOSITION II – WITH TAXES

02 the more use of debt will increase the cost of equity. Using more debt means using
cheaper capital (the cost of debt is smaller than the cost of equity), which will reduce
the weighted average cost of capital (even though the cost of equity increases).

PROFITABILITY
03 companies should use as much debt as possible (Maximize Debt). Higher Debt means
companies Return on Equity will be higher (because the equity is low)
 Modigliani & Miller

the value of a company is

determined by Earning Before
Interest and Tax and company risk.

dividend payments do not affect

bystock prices or company value
Company value is not but it influenced by how the
determined by dividends company manages the assets
they have to generate their profits
and manages risks.
 Gordon & Litner
Bird - In – Hand Theory (LEVERAGE)

There is a relationship between company’s value and dividend

policy as equity will increase if DPR (Dividend Payout Ratio)
decreased, it will be happen because investors prefer dividend
than Capital gain. It will decrease company’s leverage, investor
feel more safe and constant to consider the dividend yield.
 Bird - In – Hand Theory (PROFITABILITY)
Because investor prefer dividen than capital gain, so Retained
Earning must be low, because they pay dividend to investor by
Net After Tax. Because of the low level of Retained Earnings, the
companies Equity is also low. Hence, the Return On Equity of the
company will be high.
Bird-In-
Hand Gordon’s Value Model
Theory This model shows that if
dividend increase, the
DIVIDEND share value also increase.
In this model, dividend
payment reduces retained
earnings, that resulted in
dividend’s lower growth.
Low level of dividends
brings to the higher
discount rate, so, the
increase of share price due
to low cost of capital.
Gordon’s Dividend
Hypoteses Model based
on Lintner
Three Hypotheses of
Gordon’s:
• To receive both
dividends and capital
gain
• To receive dividends
• To receive capital gain
This model proved that
dividends have greater
impact on share price than
retained earnings
 MAJLUF
Pecking Order Theory - LEVERAGE

There is no well-defined optimal debt ratio. The attraction of

01 interest tax shields and the threat of financial distress are
assumed second-order

Debt ratios changes when there is an imbalance of internal cash

flow, net of dividends, and real investment opportunities.
02 Highly profitable firms with limited investment opportunities work
down to low debt ratios. Firms whose investment opportunities
exceed internally generated funds borrow more and more

03 Changes in debt ratios are driven by the need for external funds,
not by any attempt
to reach an optimal capital structure
Pecking The order of financing preference in Pecking Order Theory:

Order Internal Financing

Internal Financing such as Retained Earning is more profitable
and cheaper than Debt and Equity because firms do not have
Theory to pay interest or dividend.

Debt
Profitability Debt Financing is more cheaper than Equity because cost of
debt is lower than cost of equity. With using Debt firm only
need to pay interest rate about 5% to 10% of debts and it is tax
deductible.

Equity
Equity Financing is the most expensive among other methods
because of the cost of equity is always bigger than cost of
debt, because Equity demands dividend payments which
derived from Net Income after Tax. Means, if the company’s
NAT is high, they need to pay high dividend too.
 Majluf
PECKING
PECKING ORDER
ORDER THEORY
THEORY -- DIVIDEND
DIVIDEND

Companies adjust the ratio of their target dividend

payments to their investment opportunities.
The sticky dividend policy and unpredictable fluctuations of
profit and investment opportunities, this is shows that
cash flows are sometimes more than capital expenditures
and sometimes less. If more than that, the company pays
debt or invests in securities. If it is lack of that, the company
reduces their cash balance or sells their securities, rather
than reducing dividends.