Which one of the following statements is true?
A) The total value of a firm decreases as debt is initially added to an all equity firm, if taxes are considered.
B) The tax shield applies to both debt and equity financing.
C) The ideal capital structure minimizes the total tax liability.
D) Capital structure does matter when taxes are included.
E) The general conclusions of M&M Proposition II do not hold when taxes are considered.

Question

Quizplus · Accepted Answer

Capital structure does matter when taxes are included because the interest payments on debt are tax-deductible, which can reduce a firm's tax liability and affect its overall value. This is a deviation from Modigliani and Miller's Proposition I without taxes, which states that capital structure does not affect firm value.

Which One of the Following Statements Is True