In a world with no taxes,MM show that the capital structure of a firm does not affect the value of the firm.However,when taxes are considered,MM show a positive relationship between debt and firm value.

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This is the basic premise of Modigliani-Miller theorem (MM theorem) which states that the value of the firm is determined by its earning power and the risk of its underlying assets, and not by the way it is financed. In other words, in a world with no taxes, it doesn't matter whether a firm is financed by debt, equity or a mix of both, as long as the overall cost of capital (WACC) remains the same. However, when taxes are introduced, the interest on debt becomes tax-deductible, which lowers the overall cost of debt and therefore makes debt cheaper than equity. As a result, an optimal capital structure that includes some debt can increase the value of the firm as it reduces the tax liability and increases the return on equity.

In a World with No Taxes,MM Show That the Capital