When MM theory recognizes taxes and bankruptcy costs, firm value:
A)is unaffected by financial leverage.
B)steadily increases with financial leverage.
C)steadily decreases with financial leverage.
D)initially increases but then decreases as financial leverage rises.

Question

Quizplus · Accepted Answer

When MM theory recognizes taxes and bankruptcy costs, the firm value initially increases as financial leverage rises because the tax shield from interest payments outweighs the increase in bankruptcy costs. However, as financial leverage continues to rise, the increase in bankruptcy costs begins to outweigh the tax shield, causing the firm value to decrease.

When MM Theory Recognizes Taxes and Bankruptcy Costs, Firm Value