Business Case Studies & Business Publications

M&M Pizza

Schill, Michael J.

Case

M&M Pizza

Schill, Michael J.

F-1691 | Published March 11, 2013 | 3 pages Case

Collection: Darden School of Business

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Product Details

This case is used in Darden's core first year finance course. The exercise introduces in a fun way the fundamentals of financial policy that are the foundation of corporate finance. It takes the textbook treatment of the Modigliani and Miller (M&M) principles and casts it in a case format. The case is accompanied by a teaching note for instructors and spreadsheets for both instructors and students. Moe Miller, the new managing director of M&M Pizza, is considering changing the company’s capital structure to reduce the cost of capital. With the cost of debt at 4% and the cost of equity at 8%, adding a cheaper cost of funds through debt appears to be obvious. The case provides a simple framework for understanding the powerful intuition behind the foundational capital structure irrelevance propositions of Modigliani and Miller (1958). The case is written as an introductory experience in financial policy. Students are required to generate simple estimates of the cost of capital and estimate the value of debt and equity claims under various recapitalization scenarios. As the business is very simple and operates in a quasi-perfect market, the calculations require only that students are comfortable with the estimation of firm cost of capital.

• Introduce students to Modigliani and Miller’s irrelevance propositions for capital structure. • Build intuition on the conservation of value and risk across financial policies in a perfect market. • Debunk popular notions of how value is created, such as by reducing the cost of capital by borrowing at the lowest cost of funds. • Introduce the concept of tax shields and how tax savings are reflected in corporate valuation. • Provide motivation for the trade-off model of capital structure in which firms trade off the gains and costs of tax shields and financial distress.