MM Proposition I with corporate taxes states that:
I.capital structure can affect firm value by an amount that is equal to the present value of the interest tax shield;
II.by raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value;
III.firm value is maximized by using an all-equity capital structure

Question

Quizplus · Accepted Answer

MM Proposition I with corporate taxes states that capital structure can affect firm value by the present value of the interest tax shield. This means that by increasing debt, a company can lower its taxes and increase its overall value. Therefore, II is correct. However, III is incorrect as the optimal capital structure is a function of many factors, not just tax considerations. Finally, I is also correct as it is a direct consequence of the interest tax shield. Therefore, the correct answer is D.

MM Proposition I with Corporate Taxes States That