Take two businesses that are identical in all respects other than their Capitalization. One has Total Assets of $100M and no Debt. The other has a Market Capitalization of $40M and $60M of Debt. Which company is worth more? OK, a trick question.
Let’s try slightly different questions. If you are offered one percent of the common stock of one, which would you pick? No brainer. How about if you are being offered all of the assets? Another trick? What if you are being asked to lend $1M on a fixed set of terms? What if all of the existing debt (if any) will be subordinated?
Yes, some folks won a Nobel Prize for examining versions of these questions. Several times, I have taught “MM” in the hope that its theoretical insights will lead to greater skill in drafting bond covenants or setting performance targets for performance bonus plans. I’ve found greater success by going at it the other way around.
Maybe Brian and I can set up an experiment to see if theory or practice should come first? (Of course, the answer is probably some kind of hybrid, as Brian has already suggested.)
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