'Modigliani-Miller theory amplifies that the value of the levered firm is same as the value of the unlevered firm'. Elaborate the assumptions, leading to the substantiation of the proposition.

According to MM Model, under a given set of assumptions, the capital structure and its composition have no effect on the value of the firm. MM Model shows that the financial leverage does not affect and the cost of capital and value of the firm are independent of the capital structure. Thus, Total value of levered firm = Total value of unlevered firm But, this MM's proposition is based on certain assumptions, which relate to the behavior of investors and capital markets, the action of firm and the tax environment. Perfect Capital Markets : It means that investors are free to buy or sell securities. They can borrow without restriction at the same terms as the firms do and investors behave rationally. It also implied that the transaction costs do not exist. The assumption that firms and individual investors can borrow and lend at the same rate of interest is a very critical assumption for the validity of MM Proposition. Homogeneous Risk Classes : Firms operate in similar business conditions and have similar operating risk. They are considered to have similar operating risk and belong to homogeneous risk classes when their expected earnings have identical risk characteristics. It is generally implied under the MM hypothesis that firms within same industry constitute a homogeneous class. Risk : The operating risk is defined in terms of the variability of the net operating income (NOI). The risk of investors depends on both the random fluctuations of the expected NOI and the possibility that the actual value of the variable may turn out to be different that their best estimate. No taxes : There are no corporate taxes. This implies that interest payable on debt do not save any taxes. Full payout : Firms distribute all net earnings to shareholders, means firms follow a 100% dividend payout.