The Criticism Of The Modigliani And Miller Hypothesis Finance Essay

The Criticism Of The Modigliani And Miller Hypothesis Finance Essay Capital structure has a major implication to the ability of firms to meet the various needs of stakeholders. There were various studies carried out on capital structure and major development on new theories for optimal debt to equity ratio. The first milestone on the issue was set by Modigliani and Miller(1958) through which they presented in their seminal work two important propositions that shaped the economic theory behind capital structure and its effect on firm value. The Modigliani and Miller hypothesis is identical with the net operating income approach. At its heart, the theorem is an irrelevance proposition, but the Modigliani-Miller Theorem provides conditions under which a firms financial decisions do not affect its value. They argue that in the absence of taxes, a firms market value and the cost of capital remain invariant to the capital structure changes. In their 1958 articles, they provide analytically and logically consistent behavioural justification in favour of their hypothesis and reject any other capital structure theory as incorrect. The Modigliani-Miller theorem states that, in the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market, a companys value is unaffected by how it is financed, regardless of whether the companys capital consists of equities or debt, or a combination of these, or what the dividend policy is. Miller (1991) explains the intuition for the Theorem with a simple analogy. Think of the firm as a gigantic tub of whole milk. The farmer can sell the whole milk as it is. Or he can separate out the cream, and sell it at a considerably higher price than the whole milk would bring. He continues, The Modigliani-Miller proposition says that if there were no costs of separation, (and, of course, no government dairy support program), the cream plus the skim milk would bring the same price as the whole milk. The main content of the argument is that increasing the amount of debt (cream) lowers the value of outstanding equity (skim milk) and selling off safe cash flows to debt-holders leaves the firm with more lower valued equity,thus keeping the total value of the firm unchanged. Furthermore, any gain from using more of what might seem to be cheaper debt is offset by the higher cost of now riskier equity. Assumptions: The Modigliani-Miller theorem can be best explained in terms of their proposition 1 and proposition 2. However their proposition are base on certain assumption and particularly relate to the behaviour of investors, capital market, the actions of the firm and the tax environment. According to I.M Pandey(1999) the assumptions of the Modigliani Miller theorem is based on: Perfect capital markets These are securities (shares and debt instruments)which are traded in the perfect capital market situation and complete information is available to all investors with no cost to be paid. This also means that an investor is free to buy or sell securities, he can borrow without restriction at the same terms as the firm do and he behave rationally. It also implies that the transaction cost(cost of buying and selling securities) do not exist. Homogeneous risk classes Firms can be group into homogeneous risk classes. Firms would be considered to belong to a homogeneous risk class if their expected earnings have identical risk characteristics. It is generally implied under the M-M hypothesis that firms within same industry constitute a homogeneous class. Risk The risk of the investors is defined in terms of the variability of the net operating income(NOI). The risk of investors depends on both the random fluctuations of the expected NOI and the possibility that the actual value of the variable may turn out to be different than their best estimate. No taxes In the original formulation of their hypothesis, M-M assume that no corporate income taxes and personal tax exist. That is, they are both perfect substitute. Full payout Firms distribute all net earnings to the shareholders, which means a 100% payout. Proposition 1: the market value of any firms is independent of its capital structure. M-M(Modigliani and miller) argue that for firms in the same risk class the total market value is independent of the debt-equity mix and is given by capitalizing the expected net operating income by the rate appropriate to that risk class. This is their proposition 1 and can be expressed as follows: Value of firm= Market value of equity + Market value of debt = V= (S + D) = = Where V = the market value of the firm S = the market value of the firms ordinary equity D = the market value of debt = the expected net operating income on the assets of the firm = the capitalization rate appropriate to the risk class of the firm. Also, M-M extended proposition 1 by arguing that there is a linear relationship between cost the cost of equity and the financial leverage. Financial leverage is measured by the Debt to Equity ratio(D/E).The cost of equity capital can be denoted by the following relationship: = + ( ) DE Where denotes cost of equity capital; denotes overall cost of capital and denotes cost of debts of the firm L . Based on the assumption that there is no corporate tax then is equal to the rate of interest on financial leverage employed by the firm. The diagram below shows the cost of capital under the Modigliani and Miller proposition 1.http://htmlimg3.scribdassets.com/2vohdy2ptsw5n23/images/12-7ef603c995.jpg Example: Example 1 Example 2 DE 2/3 1 0.18 1.18 0.10 0.10 23.3% 26% It can be seen that due to an increase in financial leverage the risk premium of equity shareholders have increased from (23-18) = 5% to (26-18) = 8 %. We can also verify for the , which is given below: When debt equity ratio is 2:3 + = 18% The similar result is obtained when DE is 1. + = 18% It can be concluded that the overall cost of capital, which is the weighted average cost of debt and cost of equity, is unaffected even if the degree of financial leverage is increased. As per the M-M model, however , any benefits arising by substituting cheaper leverage for more expensive equity are offset by an increase in both the costs as reflected on the following graph. Arbitrage process: Arbitrage process is base on the principle that Proposition 1 is based on the assumption that 2 firms are identical except for their capital structure which cannot command different market value and have different cost of capital. Modigliani and Miller do not accept the net income approach on the fact that two identical firms except for the degree of leverage, have different market values. Arbitrage process will take place to enable investors to engage in personal leverage to offset the corporate leverage and thus restoring equilibrium in the market. Criticism of the Modigliani and Miller hypothesis: On the basis of the arbitrage process, M-M conclude that the market value of firms are not affected by leverage but due to the existence of imperfections in the capital market, arbitrage may fail to work and may give rise to differences between the market values of levered and unlevered firms. The arbitrage process may fail to bring equilibrium in the capital market for the following reasons: Lending and borrowing rates differences: Based on the assumption that firms and individuals can borrow and lend at the same rate of interest does not hold good in practice. This is so because firms which hold a substantial amount of fixed assets will have a higher credit standing, thus they will be able to borrow at a lower rate of interest than individuals. Non-substitutability of personal and corporate leverages: It is incorrect to say that personal leverage and corporate leverage are perfect substitute because of the existence of limited liability a firms hold compare to the unlimited liability of individuals hold. For examples, if a levered firm goes bankrupt, all investors will lose the amount of the purchase price of the shares. But if an investor creates personal leverage, in the event of a unlevered firms insolvency, he would lose not only his principal in the shares but also be liable to return the amount of his personal loan. Transaction costs: Transaction cost interfere with the working of the arbitrage. Due to the cost involved in the buying and selling of securities, it is necessary to invest a larger amount in order to earn the same return. As a result , the levered firm will have a higher market value. Institutional restrictions: Personal leverage are not feasible as a number of investors would not be able to substitute personal leverage for corporate leverage and thus affecting the work of arbitrage process. Corporate taxation and personal taxation: M-M theory is also criticize for the reason that it ignores the corporate taxation and personal taxation. Retained earnings: It also ignores personal aspect of financing through retained earnings. In real world , corporate will not pay out the entire earnings in the form of dividends. Investors willingness: Investors will not show much interest in purchasing low rated issued by highly geared firms.

Impact of Recess on Classroom Behavior Essay -- essays papers

Impact of Recess on Classroom Behavior When comparing the amount of time American children spend at ‘recess’ during the school day, you will see, that it is considerably less than the amount of time given by other countries. Japanese schools typically have a 10-20 min recess period between 45-min lessons or 5-min breaks between lessons, with a long play period after lunch. In Taiwan, schools typically have many recess periods during the day; children are also given 5-6 min of transition after recess in which to settle down. British schools have three 15-min recess periods throughout the day and 80-90 minutes at lunch. Many researcher believe that this recess period is key to classroom instruction. Research was done to determine the effect of a recess break on classroom behavior; specifically working, fidgeting, and listlessness. A southern urban school district with a ‘no recess policy’, granted permission for two grade 4 classes to have recess once a week so that behavior on recess days could be compared to that of behavior on non-recess days. Because recess was not in the normal daily schedule, the students would not anticipate it, and this anticipation could not effect the results. The days for recess were chosen randomly so that a pattern would not develop and be anticipated. The study looked at 43 children, 18 boys and 25 girls, from a variety of backgrounds; socially, ethnically, and economically. The school was located in middle class-upper middle class neighborhood and serves neighborhood children as well as children bussed in from transient housing. This quantitative study explained very clearly the types of children that were to be studied, the specific controls that would be used, and the results that were being anticipated. Researchers conducting this test were looking for the effectiveness that recess has on the student, if any. The children were placed into two research groups; A and B. Classroom A’s normal morning schedule is as follows. 8:00-9:30 Instruction in their own classroom 9:30-11:15 Mathematics and science in another classroom (where they were observed) 11:15-12:00 Instruction in their own classroom On the days when the children had recess, they took a break from mathematics and science to go outside from approximately 10:30-10:50. Classroom B’s normal morning schedule is as foll... ...gnificant research for educators to know and that if used properly it could, and would, increase the learning in a classroom. Most public schools have a period set aside each day for recess that coincides with the lunch schedule. This proves that schools are taking advantage of the recess method. I think that the ‘anticipation factor’ is key to giving recess the greatest impact possible. Schools would have to devise a schedule that would shift the recess periods around so students would be unaware of the days scheduled recess time. This would be dependent on teacher and administrator cooperation. I believe that the research done has ‘real world’ significance to teachers and students alike. The changes that would have to take place are minimal and the effects that would be achieved are obvious from the start. Teachers everywhere would benefit from using this information in the day to day running of their classrooms by saving countless minutes trying to keep the class on task. We have learned that the most important parts to a lesson are the ‘first’ and ‘last’ facts. When you add recess into the daily schedule you have another ‘start’ and ‘finish’ for kids to remember.

General Electric Medical Systems

1. Q 1. What is the underlying logic behind the global product idea? What are the costs and the benefits that are expected? Global Products Company(GPC) strategy is based on the following underlying logical premises: a. Markets for medical equipment are systems are becoming increasingly global in nature. They are no more restricted to only the developed First and Second World countries having advanced healthcare systems. The burgeoning market is that of emerging and developing economies. Thus, there is a need to meet the growing demand for affordable medical equipment in these economies and retain its market leadership b. Needless to say that low-cost leverage is the only way to win a large chunk of this new pie and therefore GEMS has to shift to a cost-efficient strategy c. GEMS realised the potential of tapping production & sourcing centres where there was parity in output quality and labour skill-sets but overall cost was much lower. d. The GPC strategy involved sourcing quality components from the most cost-effective suppliers and establishing the manufacturing bases in most cost-effective geographies. e. As most of the GEMS manufacturing involved sourcing complicated components from across the globe to two-three manufacturing/assembling centres and then distributing across the globe from these centres, the challenging aspect of GPC was in the development of intermediaries along the supply chain to ensure un-interrupted supply & production flows. The following are some of the costs and benefits of the above mentioned strategy of globalizing production to facilitate a low cost production: Benefits: 1. As materials form 80% of the manufacturing cost, sourcing of materials from low-cost countries would enable a significant amount of saving. The key would be to develop long-term relationships with local suppliers and once that is done, it means unparalleled cost savings in future. 2. Having manufacturing centres in low-cost-labour countries would also enable a substantial cost reduction as labour formed 20% of the manufacturing cost. 3. Now, as labour and materials form almost 85% of the total variable cost, substantial reduction in both would enable GEMS to have a cost reduction to he tune of approximately 30% in the total cost. It has to be noted that the incremental fixed cost in case of GEMS was close to nil (Exhibit 7). Costs: 1. In addition to the fixed costs that had to be incurred additionally to enter into the low-cost countries, other GPC-specific costs included inventory, logistics, documentation, and import- duty costs relating to moving materials and products around the world. 2. Developing a long-standing relationship with new suppliers in these low-cost countries was another area that required considerable allocation of time and effort. . Reducing investments in developed countries, from where bulk of their demand came, meant deteriorating relationship and loss of concessions from these countries. 4. Costs related to hiring less experienced workforce in these new locations, and human toll on the workforce as a result of long trips from home for the employees from both old locations and headquarters. If we analyse GEMS’s strategy mentioned in the body above using the AAA model, we can conclude that it is primarily using the arbitrage strategy of globalization with some elements of aggregation. Q. 2 Should the global product philosophy be changed or altered to suit the China market? Please identify both sides of the argument and take a position explaining the rationale behind your stand. Does it make economic sense? The choice between continuing with the current Global Product Concept(GPC) and adopting â€Å"In China for China† for the low end products is a very difficult call for GE managers. On one hand there are several advantages of adopting â€Å"In China for China† such as: In China there is a huge growth potential for medical diagnostics and as of now it is the world's third largest market for the same. By adopting â€Å"In China for China†, GEMS can design and customize products according to local needs in China and further the GE managers believe that China being a nationalistic country, domestically produced products will have greater demand than imported ones. There are other factors like low incremental fixed cost for moving facilities to China, avoidance of duties and tariffs, availability of cheaper local labor and low transportation cost all of which would help in cost saving for GEMS. On the other hand in order to adopt â€Å"In China for China† strategy GEMS will have to break the GPC concept which may result in ecreased quality due to lack of readily available skilled labor and reduced cost cutting efficiency. Also the management will have to address the challenge of development of suppliers which may result in inefficiency. GEMS do not have good history of managing joint ventures because of the unethical practices of the partner which eventually lead GEMS a cquiring the partners. As understood from the case there are two different market segments in China namely the high end markets served which is served only through imports and the low end markets which is served through domestic production. The adoption of â€Å"In China for China† strategy will result in the company distancing itself from high end customers which will end up in losing the revenue for the business to high end customers. Considering all these factors we suggest that it is better for GEMS not to adopt â€Å"In China for China† strategy and to stay with Global Product Concept. Q3. Should GEMS be aggressively pursuing genomics and healthcare-IT related opportunities in addition to or instead of the China opportunity? What priorities would you suggest? Explain your reasoning carefully? No doubt, being third largest healthcare market with tremendous growing potential in future, China is a lucrative market that GEMS can’t easily neglect. But at the same time, with the growth of technological advancement in the field of healthcare, genomics and healthcare-IT related products and services going to have an important role in the coming decades and the companies having those expertise will bound to dominate the global healthcare market in future for sure. So we think that GEMS should take both the China opportunity and the genomics and Healthcare –IT related opportunities seriously. We believe that GEMS has the capacity to look at both the opportunities simultaneously obviating the need to sacrifice one for the other. The company’s strong financial condition along with its strong emphasis on R&D would help the organization in meeting both the objectives. China Opportunity : But in doing so GEMS should initially put more focus on the China market than the R&D on genomics and healthcare-IT projects. Because it is very important for GEMS to catch hold of the China’s market before other competitors like Siemens, Philips. Also the gestation period of genomics and healthcare related projects are too high usually 5-10 years and in such a situation to maintain a good balance sheet GEMS should have a good market share in China. The low end product accounts for 20% of the global sales and to succeed in the low end , presence is Chinese market is a must for any company. Secondly, The China opportunity requires GEMS to shift the production from the other parts of the world to China. The incremental cost associated with that shift in production process is a mere $1 million which should not be an obstacle in GEMS China policy. So GEMS can easily do that without worrying too much about the financial aspects. Genomics and healthcare-IT related opportunities Genomics and preventive health care is going to play a deciding factor in coming decades. But these projects are far more complex than what GEMS did till now. Genomics requires not only technological know-how but also expertise on biomedical science which presently GEMS lacks off. So for better output from these R&D, Tie-up with pharmaceutical companies that develop viruses and chemical reagents would help GEMS to understand and increase their expertise on bio medical science. Collaboration with leading universities around the world on researches on topics relevant to these projects would also help GEMS. Funding for these researches, Supplying machines and tools to support those researches would help GEMS in getting good responses from R&D teams around the world. So with the steps mentioned above and few modifications to the present system, GEMS can take both the opportunities

Healthcare Enhancing Patient Safety - 1644 Words

Pyxis in Healthcare:Enhancing Patient Safety NR 340: Information Systems In Healthcare Instructor: Amy Johnson Team Yellow Pyxis: An Introduction The Pyxis medication dispensing system is used in a wide variety of medical settings to aid in the safe administration of medication. The Pyxis system simplifies the inventory, stocking, ordering and distribution of medications through the use of information systems. Objectives Discuss the purpose and use of the Pyxis. Discuss the history and background of the Pyxis medication dispensing system. Discuss the impact Pyxis use has had on healthcare. Discuss the effectiveness of Pyxis use in regards to patient safety Discuss the advantages and disadvantages of Pyxis use. 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