Which of the following statements concerning capital structure theory is NOT CORRECT?
A) The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt.
B) Under MM with zero taxes, financial leverage has no effect on a firm's value.
C) Under MM with corporate taxes, the value of a levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt.
D) Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing.

Question

Quizplus · Accepted Answer

The statement "Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing" is not correct. In fact, under MM theory, rs (the cost of equity) is assumed to be constant, while the cost of debt is assumed to increase as financial leverage increases. The tax benefits of debt financing therefore exceed the increase in the cost of debt, leading to an overall decrease in the weighted average cost of capital (WACC) and an increase in firm value.

Which of the Following Statements Concerning Capital Structure Theory Is