The Modigliani-Miller Model

The Modigliani-Miller model is a financial theory that states that the value of a firm is independent of its capital structure.

The model explains the relationship between capital structure and firm value by arguing that the risk of a firm is determined by its operating income, not by its capital structure.

This means that the cost of equity for a levered firm is the same as the cost of equity for an unlevered firm, assuming that the two firms have the same operating income.

An arbitrage opportunity is a situation in which an investor can profit without taking on any additional risk. In the context of the MM model, an arbitrage opportunity exists when the market prices of levered and unlevered firms are not equal.