The reason that MM Proposition I does not hold good in the presence of corporate taxes is because:
A) Levered firms pay lower taxes when compared with identical unlevered firms
B) Bondholders require higher rates of return compared with stockholders
C) Earnings per share are no longer relevant with taxes
D) Dividends are no longer relevant with taxes

Question

Quizplus · Accepted Answer

MM Proposition I states that in the absence of taxes, the capital structure of a firm is irrelevant to its value. However, in the presence of corporate taxes, levered firms pay lower taxes compared to identical unlevered firms due to the tax-deductible interest payments made on debt. This makes the cost of capital for levered firms lower, leading to a lower overall WACC and a higher firm value. Therefore, MM Proposition I does not hold good in the presence of corporate taxes.

The Reason That MM Proposition I Does Not Hold Good