The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because:
I.debt is more risky than equity;
II.bankruptcy and its attendant costs are a disadvantage to debt;
III.the payment of personal taxes may offset the tax benefit of debt
A)I only
B)II only
C)III only
D)II and III only

Question

Quizplus · Accepted Answer

Option I is not correct because the MM theory assumes that there are no taxes or bankruptcy costs, so it does not consider the relative risk of debt and equity. 
Option II is correct because MM theory assumes that bankruptcy costs are zero, which is not the case in reality. Bankruptcy costs can significantly affect a company's cost of capital and make it difficult for firms to issue debt. 
Option III is also correct because personal taxes can offset some of the tax benefits firms receive from issuing debt, making it less attractive to issue debt.

The MM Theory with Taxes Implies That Firms Should Issue