A finance theorem stating that, under perfect capital‑market assumptions (no taxes, bankruptcy costs, transaction costs, asymmetric information, or investor heterogeneity) and given fixed real investment policy, a firm's market value is invariant to its choice of capital structure (the mix of debt and equity).

Principle

Under the stated assumptions, changes in debt–equity composition do not alter firm value because investors can replicate corporate leverage through personal borrowing or lending, so financing choices only reallocate cash flows without creating net value.

Demonstration

Illustrative scenario: Two otherwise identical firms differ only in financing—Firm A is all equity, Firm B mixes debt and equity. In a frictionless market with identical cash‑flow forecasts and no taxes, arbitrage by investors who borrow or lend personally yields identical required returns and market prices for both firms, so both trade at the same value.

Misapplication

Treating the theorem as a descriptive guide in real markets without acknowledging taxes, bankruptcy risk, agency costs or information asymmetries. The error is assuming the invariance holds when key assumptions (e.g., absence of corporate taxes or financial distress costs) are violated.

Consequence

Provides a theoretical baseline: deviations of observed firm values from MM predictions indicate the presence and quantitative importance of real‑world frictions (tax shields, distress costs, agency problems, asymmetric information), guiding empirical and policy analysis of capital structure.

Reversal

Introduce corporate taxes, and the value of a levered firm exceeds the unlevered firm by the present value of tax shields; introduce bankruptcy or agency costs and the relation becomes non‑monotonic, creating an optimal trade‑off between tax benefits and distress costs.

Boundary

Applies to valuation under perfect capital markets with fixed investment policy and homogeneous expectations. It excludes settings with taxes, bankruptcy costs, transaction costs, agency conflicts, differential information, investor segmentation, or when financing affects real investment decisions.

Semantic Tension

Trade‑off theory: MM sets a frictionless null hypothesis that competes with theories that treat taxes, bankruptcy costs and information frictions as determinants of an empirically optimal capital structure.

Synthesis

The theorem is a null model that isolates financing effects: its real value is diagnostic—differences from its prediction identify which frictions matter and therefore where capital‑structure choices can influence firm value.