Which of the following situations obeys Modigliani and Miller's propositions regarding financial gearing (in a world with no tax)?
A) Company B has an enterprise value of £550m when it is financed entirely by equity and a value of £600m when 40 per cent of its capital is debt.
B) Company D has an enterprise value of £50m when debt is 60 per cent of total capital and an enterprise value of £50m when debt is 95 per cent of total capital.
C) Company A has a weighted average cost of capital (WACC) of 14 per cent and an enterprise value of £10m when debt is 30 per cent of total capital, and a WACC of 12 per cent at a debt level of 50 per cent of total capital.
D) Company C has the lowest weighted average cost of capital at the highest possible gearing level.

Question

Quizplus · Accepted Answer

Modigliani and Miller's propositions state that in a world with no tax, the capital structure of a company does not affect its overall value. Thus, the enterprise value should remain constant regardless of changes in the capital structure. Option B presents two scenarios where the enterprise value remains constant despite changes in the level of debt, which obeys Modigliani and Miller's propositions. Options A and C show changes in enterprise value due to changes in capital structure, which does not obey the propositions. Option D's statement is not enough to determine if it obeys the propositions, and thus cannot be chosen.

Which of the Following Situations Obeys Modigliani and Miller's Propositions