Sample Essay

The theory presented here by the work of Modgiliani and Miller has been one of the defining works of modern finance and can be said to be the foundation of much of the subsequent work that has been done in the field. The whole study can be looked at from the perspective of the existing literature presented by economic theorists in the 1950s. These theories were ripe with detrimental simplifications such as regarding the fixed income securities such as bonds as being able to provide a sure source of steady income. The cost of capital thus generally held to be the interest rate on bonds meaning that the firm will invest until the marginal yield gets up to the level of the marginal interest.

The authors took the theory and tested it through the use of data from an oil company and electricity utility companies in 1954-1955. The conclusions from this seemed to appear in favor of the propositions put forth by Modgiliani and Miller which verifies their results to a great extent. Once these two propositions were shown to stand, it led to the third proposition by extension which answered the third important concern of financial experts. It basically showed that the type of security used among the many available has little or no effect on the cut off point for investment that a firm decides. This has the implication of changing the way financial experts and economists appraise alternative investments.

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