The American Economic review VOLUME XLVIII JUNE 1958 NUMBER THREE THE COST OF CAPITAL, CORPORATION FINANCE AND THE THEORY OF INVESTMENT By FRANCO MODIGLIANI AND MERTON H. MILLER What is the"cost of capital "to a firm in a world in which funds s are sed to acquire assets whose yields are uncertain; and in which capital an be obtained by many different media, ranging from pure debt instru ments, representing money-fixed claims, to pure equity issues, giving holders only the right to a pro-rata share in the uncertain venture? This question has vexed at least three classes of economists: (1)the cor poration finance specialist concerned with the techniques of financing firms so as to ensure their survival and growth; (2)the managerial economist concerned with capital budgeting; and(3) the economic heorist concerned with explaining investment behavior at both the micro and macro levels In much of his formal analysis, the economic theorist at least has tended to side-step the essence of this cost-of-capital problem by pro- ceeding as though physical assets -like bonds--could be regarded as yielding known, sure streams. Given this assumption, the theorist has concluded that the cost of capital to the owners of a firm is simply the rate of interest on bonds; and has derived the familiar proposition that the firm, acting rationally, will tend to push investment to the point 0间( The authors are, respectively, professor and associate professor of economics in the uate School of Industrial Admin the discussants of the paper, Evsey Domar, Robert Eisner and John Lintner, and subse- ently by James Duesenberry. They are also greatly indebted former colleagues and students at Carnegie Tech who served so often and with such remark able patience as a critical forum for the ideas here presented Numerous references to it will be found thpoug prt thm s per tho t nse e t1上如 completeness. One phase of the problem which we do not consider explicitly but which has a considerable literature of its own is the relation between the cost of capital and public utility ates. For a recent summary of the"cost-of-capital theory"of rate regulation and a brief di ssion of some of its implications, the reader may refer to H. M. Somers [20