Inflation in Brusov–Filatova–Orekhova Theory and in its Perpetuity Limit – Modigliani – Miller Theory

In this paper the influence of inflation on capital cost and capitalization of the company within modern theory of capital cost and capital structure – Brusov–Filatova–Orekhova theory (BFO theory) (Brusov et al. 2011, 2013; Filatova et al., 2008) and within its perpetuity limit – Modigliani – Miller theory is investigated. By direct incorporation of inflation into both theories, it is shown for the first time that inflation not only increases the equity cost and the weighted average cost of capital, but as well it changes their dependence on leverage. In particular, it increases growing rate of equity cost with leverage. Capitalization of the company is decreased under accounting of inflation

The Golden Age of the Company: (Three Colors of Company's Time)

In this paper we investigate the dependence of attracting capital cost on the time of life of company n at various leverage levels, at various values of capital costs with the aim of define of minimum cost of attracting capital. All calculations have been done within modern theory of capital cost and capital structure by Brusov - Filatova - Orekhova (Brusov et al. 2011a,b,c,d,e; 2012 a,b; 2013 a,b,c; 2014 a,b; Filatova et al. 2008). It is shown for the first time that valuation of WACC in the Modigliani - Miller theory (Modigliani et al. 1958; 1963; 1966) is not minimal and valuation of the company capitalization is not maximal, as all financiers supposed up to now: at some age of the company its WACC value turns out to be lower, than in Modigliani - Miller theory and company capitalization V turns out to be greater, than V in Modigliani - Miller theory. It is shown that, from the point of view of cost of attracting capital there are two types of dependences of weighted average cost of capital, WACC, on the time of life of company n: monotonic descending with n and descending with passage through minimum, followed by a limited growth. The first type takes place for the companies with low capital costs of the company, characteristic for the western companies. The second type takes place for higher capital costs of the company, characteristic for the Russian companies as well as for companies from other developing countries. This means that latter companies, in contrast to the western ones, can take advantage of the benefits, given at a certain stage of development of company by discovered effect. Moreover, since the "golden age" of company depends on the company's capital costs, by controlling them (for example, by modifying the value of dividend payments, that reflect the equity cost), company may extend the "golden age" of the company, when the cost to attract capital becomes a minimal (less than perpetuity limit), and capitalization of companies becomes maximal (above than perpetuity assessment) up to a specified time interval. Concluded that existed up to the present conclusions of the results of the theory of Modigliani-Miller (Modigliani et al. 1958; 1963; 1966) in these aspects are incorrect. We discuss the use of opened effects in developing economics (Brusov et al. 2015)

Weighted average cost of capital in the theory of Modigliani-Miller, modified for a finite lifetime company

The theory of the capital cost and the capital structure by Modigliani and Miller (MM) is based on many assumptions, removal of which significantly alters its conclusions. While the account of corporate and individual taxes, the possibility of bankruptcy and a number of other assumptions have received considerable attention, the MM assumption that all financial flows are perpetuity (the lifetime of the company is infinite) is much less studied. In fact, the lifetime of the company is always, of course, finite and the inclusion of this significantly changes formulae obtained by MM, in particular for the Weighted Average Cost of Capital (WACC). In this article, we consider the WACC of the company in the theory of MM and modify MM's theory for a finite lifetime company. For the first time, we derive the analytical expression for WACC of the company with arbitrary lifetime. In two limited cases - 1 year and perpetuity companies - our expression gives the well-known results of Myers and MM, correspondingly. We have solved the obtained equation for a 2 year company and compared this result with those of Myers and MM. It shows that WACC values for 2 year company is closer to MM (perpetuity) limit than to Myers (1 year) one at small equity cost (just above the debt cost) while at bigger equity cost, it is closer to Myers limit than to MM one. Algorithm for finding of WACC in the case of arbitrary lifetime of the project has been developed. The use of the obtained equations for the projects of n years, and for companies operating in the market n years significantly alters the assessment of the WACC of the company.