a world with no taxes, MM show that a firm's capital structure does not affect the firm's value However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

Question

Quizplus · Accepted Answer

This is the basic principle of MM's theory of capital structure, which states that the value of a firm is independent of its capital structure in the absence of taxes and other market imperfections. When taxes are introduced, the optimal capital structure involves a trade-off between the tax advantages of debt financing and the costs of financial distress. As a result, a firm's value can be maximized by increasing its debt level up to a certain point, beyond which the costs of financial distress start to outweigh the tax benefits.

A World with No Taxes, MM Show That a Firm's