CORPORATIONS MAY ISSUE VARIOUS types of financial contracts to investors. The market price of each security depends upon its claim on corporate resources and its influence on taxes. Modigliani and Miller [5, 6] and Cox and Ross [2] elaborate an arbitrage theory of security valuation. Briefly, in the absence of taxes, the total package of claims issued by the firm accounts for all its value so the package is equivalent to simple equity. The main body of the Modigliani and Miller (M & M) theory is adopted in this paper. The objective is to demonstrate a few problems in simple constructs of the theory. In particular, Hamada's [3] equilibrium derivation of the M & M valuation equation illustrates the traps that await a naive treatment of debt when limited liability equity and corporate taxes are considered. This analysis concerns the effect on corporate value of substituting debt for equity in the presence of corporate taxes. For simplicity, personal income taxes are ignored.' Hamada's basic derivation of the M & M model is sketched in section 2. Section 3 shows the problems that arise with a simple treatment of debt. An example illustrates the problems concretely. Section 4 gives a modified development of the M & M valuation relationship that avoids simple problems. In the process, the interaction between risk and valuation for corporate claims is reestablished. Concluding remarks are in section 5.