MODIGLIANI AND MILLER THEORY OF INVESTMENT 265 is at the level of the firm and the industry that the interests of the vari- ous specialists concerned with the cost-of-capital problem come most closely together, Although the emphasis has thus been placed on partial equilibrium analysis, the results obtained also provide the essential building blocks for a general equilibrium model which shows how those prices which are here taken as given, are themselves determined. For reasons of space, however, and because the material is of interest in its own right, the presentation of the general equilibrium model which rounds out the analysis must be deferred to a subsequent paper. I. The Valuation of Securities, Leverage, and the Cost of Capit A. The Capitalisation Rate for Uncertain streams As a starting point, consider an economy in which all physical assets e owned by corporations. For the moment, assume that these corpora- tions can finance their assets by issuing common stock only; the intro duction of bond issues, or their equivalent, as a source of corporate funds is postponed until the next part of this section The physical assets held by each firm will yield to the owners of the firm-its stockholders-a stream of " profits'over time; but the ele ments of this series need not be constant and in any event are uncertain This stream of income, and hence the stream accruing to any share of common stock, will be regarded as extending indefinitely into the future We assume, however that the mean value of the stream over time, or average profit per unit of time, is finite and represents a random vari- ble subject to a(subjective) probability distribution We shall refer to the average value over time of the stream accruing to a given share as the return of that share; and to the mathematical expectation of this average as the expected return of the share, Although individual inves- tors may have different views as to the shape of the probability distri. These propositions can be restated analytically as follows: The assets of the ith firm gener- ate a stream whose elements are random variables subject to the joint probability distribution x[x4(1,x4(2)…X4() The return to the ith firm is defined M=把7x Xi is itself a random variable with a probability on (Xi whose form is determined iquely by expected return xi is define the number of shares outstanding, the return of 4 (Xa)dXe. If N is distribution pi dr=(Nx)d(Nx)and expe c品 元=(1/)X