Abstract
Recently, we have modified the theory of Nobel Prize winners Modigliani and Miller (MM theory), which is a perpetuity limit case of the general theory of capital cost and capital structure—Brusov–Filatova–Orekhova theory, into two ways: we apply it for rating methodologies needs and later we generalized it for the case of advance payments of tax on profit, which is widely used in practice (MMM theory). In this chapter, we use the modified Modigliani–Miller theory (MMM theory) and apply it for rating methodologies needs. The financial “ratios” (main rating parameters) were introduced into MMM theory. The dependence of the weighted average cost of capital (WACC), which plays the role of discount rate in financial flows discounting in rating methodologies, on coverage and leverage ratios is analyzed. Obtained results will help improve the existing rating methodologies. During the last couple of years, we have suggested a new approach to rating methodology of non-financial issuers, as well for project rating (for long-term projects as well as for projects of arbitrary duration) (Brusov et al. 2018, Ratings of the investment projects of arbitrary durations: new methodology. J Rev Global Econ 8:437–448, 2019, Modification of the Modigliani–Miller theory for the case of advance payments of tax on profit. J Rev Global Econ 9:257–268, 2020). The key factors of a new approach are: (1) the adequate use of discounting of financial flows virtually not used in existing rating methodologies and (2) the incorporation of rating parameters (financial “ratios”) into the modern theory of capital structure (Brusov–Filatova–Orekhova (BFO) theory) and into its perpetuity limit.
Highlights
In our previous papers (Brusov et al 2018; 2019; 2020b) we have applied the theory of Nobel Prize winners Modigliani and Miller, which is the perpetuity limit of the general theory of capital cost and capital structure – Brusov–Filatova–Orekhova (BFO) theory (Brusov et al 2011; 2014; 2015; 2018) for rating needs
These consequencies are as following: weighted average cost of capital (WACC) starts depend on debt cost kd, WACC turns out to be lower than in case of classical Modigliani–Miller theory and company capitalization becomes higher than in ordinary Modigliani–Miller theory.We show that equity dependence on leverage level L is still linear, but the tilt angle with respect to L–axis turns out to be smaller: this could lead to modification of the divident policy of the company
We have developed new modern methodologies for rating of non-financial issuers and of project ratings based on the use of the modern theory of cost and capital structure (BFO theory (Brusov – Filatova – Orekhova theory) and of its perpetuity limit (Modigliani – Miller theory (MM theory), as well as modern investment models created by the authors (Brusov et al 2018; 2019; 2020b)
Summary
In our previous papers (Brusov et al 2018; 2019; 2020b) we have applied the theory of Nobel Prize winners Modigliani and Miller, which is the perpetuity limit of the general theory of capital cost and capital structure – Brusov–Filatova–Orekhova (BFO) theory (Brusov et al 2011; 2014; 2015; 2018) for rating needs It has become a very important step in developed of a qualitatively new rating methodology. We have shown that this generalization leads to some important consequencies, which change seriously all the main statements by Modigliani and Miller (Мodigliani and Мiller, 1958; 1963; 1966) These consequencies are as following: WACC starts depend on debt cost kd, WACC turns out to be lower than in case of classical Modigliani–Miller theory and company capitalization becomes higher than in ordinary Modigliani–Miller theory.We show that equity dependence on leverage level L is still linear, but the tilt angle with respect to L–axis turns out to be smaller: this could lead to modification of the divident policy of the company. Obtained results make possible to use the power of this theory in the rating and create a new base for rating methodologies, by other words this allows develop a new approach to methodology of rating, requiring a serious modification of existing rating methodologies
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