MM proposition 1 says that value of a firm is independent from its financial structure. If this is the case then the ideal financial structure is 100% debt.
But fortunately this is not the case otherwise everything on the earth might be held by banks as collateral. The reasons for the current scenario is different than advocated by MM are
1. Arbitrage mechanism has its limits.
2. Interest rate on personal debt is different from corporate debt because of underlying collateral, size of debt and remaining borrowing capacity.
3. Borrowing capacity of corporations as well as its shareholders is limited because there is a real cost of bankruptcy.
4. Capital markets are not perfect, there is asymmetry of information between corporations and its capital providers.
5. Interest rate varies with the leverage because of risk of default.
6. There is no “equivalent return” class because the underlying risk is different from firm to firm, which is accumulation of numbers of factors.
7. Firms within the same industry post very different operating income because of difference in strategy pursued.
8. Securities of all firms in the world are not traded on capital markets.
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