M & M Proposition I with taxes is based on the concept that:
A)the optimal capital structure is the one that is totally financed with equity.
B)the capital structure of a firm does not matter because investors can use homemade leverage.
C)a firm's WACC is unaffected by a change in the firm's capital structure.
D)the value of a firm increases as the firm's debt increases because of the interest tax shield.
E)the cost of equity increases as the debt-equity ratio of a firm increases.

Question

Quizplus · Accepted Answer

M & M Proposition I with taxes states that the value of a firm increases as the firm's debt increases because of the interest tax shield. This proposition assumes that tax shields are an important factor in the cost of capital, and that investors are rational and make their investment decisions based on after-tax cash flows. Therefore, the optimal capital structure for a firm is one that includes some level of debt financing to take advantage of the tax benefits.

M & M Proposition I with Taxes Is Based on the Concept