Theoretical market value of the company. It also

Theoretical Framework

This section covers the theories that support the relationship between

leverage and profitability of the firm. These theories include:

theorem, Pecking Order Theory and Trade-off Theory.


Modigliani-Miller Theorem


Modigliani-Miller (1958) maintains that a firm’s market value is
calculated by the risk

associated with the underlying assets of the firm and also on the
earning capacity of

the firm. The hypothesis additionally expresses that the market
estimation of the firm isn’t influenced by the decision of financing the
ventures or on the choices of disseminating the

profits. The three ways that a firm can choose to fund the speculations

getting outside capital, issuing the offers and reinvesting the
benefits. As per

the hypothesis, under some market presumptions regardless of whether the
firm ventures are

financed with value or obligation has no effect. The Modigliani-Miller
hypothesis is

all the time alluded to as the capital structure immateriality standard.

This recommends

the valuation of a firm is unimportant to the capital structure of an
organization. Regardless of whether a firm is exceptionally utilized or has
bring down obligation part in the financing blend, it has no bearing on the
estimation of a firm (Modigliani and Miller, 1963).


Modigliani and Miller Approach additionally expresses that the market
estimation of a firm is

influenced by its future development prospect separated from the hazard
associated with the speculation. The hypothesis expressed that estimation of
the firm isn’t reliant on the decision of capital structure or financing choice
of the firm. On the off chance that an organization has high development
prospects, its reasonable worth is higher and henceforth its stock costs would
be high. In the event that speculators don’t see appealing development
prospects in a firm, the market estimation of that firm would not be that
extraordinary (Miller, 1977).


Going by the assumptions of this theory on no taxes, the capital
structure does not

effect the valuation of a firm. In other words, leveraging the company
does not

improve the market value of the company. It also proposes that debt
holders in the

company and equity share holders have the same precedence, that is,
earnings are split

equally amongst them.


The advocates of this hypothesis contend that money related use is in
guide extent to

the cost of value. With increment in the red part, the value investors
see a higher hazard to the organization. Consequently, consequently, the
investors expect a higher return, consequently expanding the cost of value. The
hypothesis expect that obligation holders have a high ground the extent that
claim on income is concerned. In this manner, the cost of obligation decreases.