The cost of debt is generally lower than the cost of equity; however, according to __________, replacing equity with debt will not change the value of the firm because the savings attributable to the lower cost of debt financing will be offset by the higher required return on the remaining equity.
A) M&M Proposition I with taxes.
B) M&M Proposition I without taxes.
C) The static theory of capital structure.
D) M&M Proposition II without taxes.
E) M&M Proposition II with taxes.

Question

Quizplus · Accepted Answer

M&M Proposition I without taxes states that in a perfect market, the capital structure of a firm does not affect its overall value. Thus, replacing equity with debt does not change the firm's value because any savings from cheaper debt are offset by increased equity risk.

The Cost of Debt Is Generally Lower Than the Cost