What role does each of MM’s assumptions play in their theory of the debt-equity mix?

MM’s key assumptions and the role played by each are:

(1) Unlimited borrowing and lending is available to all market participants at one rate of interest. Role: makes the cost of personal and corporate borrowing and lending the same.

(2) Individual margin borrowing is secured by the shares purchased, the borrower’s liability is limited to the value of these shares, there are no costs to bankruptcy. Role: makes the risk of personal and corporate borrowing and lending the same.

(3) All companies can be grouped into equivalent risk classes. Role: enables investors to identify companies with identical business risk.

(4) Capital markets are perfect. Role: permits investors to easily and costlessly arbitrage between securities of companies which differ only in their financing mix.

(5) There are no corporate income taxes. Role: prevents the tax code from making debt financing more valuable by allowing interest and not dividends as a tax deduction.

(6) Shareholders are indifferent to the form of their returns, all returns are taxed at the same rate. Role: prevents investors from seeing any difference in value between interest, dividends, and capital gains.