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MARCH1974 No. 1 INTERACTIONS O F CORPORATE FINANCING AND INVESTMENT DECISIONS-IMPLICATIONS FOR CAPITAL BUDGETING STEWART MYERS* C. I. INTRODUCTION EVERYONE seems to agree that there are significant interactions between corporate financing and investment decisions. The most important argument to the contrary-embodied in Modigliani and Millerâs (MMâs) famous Proposition I-specifically assumes the absence of corporate income taxes; but their argument implies an interaction when such taxes are recognized. Interactions may also stem from transaction costs or other market imperfections. The purpose of this paper is to present a general approach for analysis of the interactions of corporate financing and investment decisions, and to derive the approachâs implications for capital investment decisions. Perhaps the most int.eresting implication is that capital budgeting rules based on the weighted average cost of capital formulas proposed by MM and other authors are not generally correct. Although the rules are reasonably robust, a more general âAdjusted Present Valueâ rule should, in principle, be used to evaluate investment opportunities. The paper is organized as follows. Section I1 presents the framework for my analysis, which is a mathematical programming formulation of the problem of financial management. The conditions for the optimum and the implications for corporate investment
The Journal of Finance – Wiley
Published: Mar 1, 1974
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