Taxes, M‐M Propositions and Government’s Implicit Cost of Capital in Investment Projects in the Private Sector

The corporate tax claim of the government is internalised in the analysis of the corporation's capital structure. In this framework the M‐M Propositions are rederived. In the proposed approach, the current value of the firm is calculated on a before‐tax basis, and is equal to the sum of present values of equity, debt, and government claim. An enhanced M‐M model is derived, which is more representative of modern financial realities, and has significant implications for the practice of financial analysis. The paper highlights the potential conflict of interest among the different claimholders in making an investment decision. The model presented here allows us to analyse the tradeoffs among various policies available to the government to encourage investments to their socially optimal level.