The Modigliani–Miller Theory with Arbitrary Frequency of Payment of Tax on Profit

Abstract

AbstractThe tax shield plays a crucial role in both main capital structure theories: Brusov–Filatova–Orekhova (BFO theory) and its perpetuity limit Modigliani–Miller theory. How it is formed influences the results of both theories. To study this problem, we modify for the first time the Modigliani–Miller theory for the case of arbitrary frequency of payment of tax on profit. Combining the theoretical consideration with numerical calculations within MS Excel, we show that: (1) all Modigliani–Miller theorems, statements and all formulas change; (2) all main financial indicators, such as the weighted average cost of capital, WACC, company value, V, and equity cost, ke, depend on the frequency of tax on profit payments. This allows to company manage WACC, V, ke, etc. by choosing the number of payments of tax of profit p per year; (3) in case of income tax payments more than once per year (at p ≠ 1), as it takes place in practice, the weighted average cost of capital, WACC, company value, V and equity cost, ke start depend on kd, while in ordinary (classical) Modigliani–Miller theory all these values DO NOT depend on kd; (4) the tilt angle of the curve of equity cost, ke (L), decreases with the number of payments of tax of profit p, this modifies the dividend policy of the company, because the economically justified value of dividends is equal to equity cost; (5) obtained results allow to company choose the number of payments of tax of profit per year, as many, as it is profitable to it (of course, within actual tax legislation): more frequent payments of income tax are beneficial for both parties: for the company and for the tax regulator.KeywordsModified Modigliani–Miller theoryFrequency of payment of tax on profitEquity costThe weighted average cost of capitalCompany value