Can anyone please explain in as much detail as possible, How does MM1 and MM2 with and without taxes relate to the Hamada equation?
what do you mean by Hamada equation?
the Hamada equations which are:
- β_{a}=β_{e}/(1+D/E) without taxes
and 2. β_{ua}=β_{e}/(1+(1-Tax rate)D/E) with taxes.
So basically how do these equations relate to the Miller and Modigliani propositions?
What does MMII (with taxes, you can deduce the other easily) state? That required return of a levered company = required return of an unlevered company + (required return of an unlevered company - cost of debt)*D/E*(1-t).
The Hamada equation states the same regarding beta - only keep in mind that beta of debt is 0, so beta of a levered company = beta of an unlevered company + (beta of an unlevered company - 0)*D/E*(1-t). Using basic algebra you can solve for beta of the unlevered company and get the same equation you posted.
Okay, thanks Nenorr. So what you’re basically saying is that the Hamada equation is based on the MM propositions? I was just want to be clear as how to word it correctly because my lecturer said we should know how to explain the relation in words.
I worked on a similar problem in a corporate finance textbook. I found that required return on equity calculated using MM and using beta+CAPM did not quite yield the same result.