Which of the following statements are correct in relation to MM Proposition II with no taxes? I.The return on assets is equal to the weighted average cost of capital.
II)Financial risk is determined by the debt-equity ratio.
III)Financial risk determines the return on assets.
IV)The cost of equity declines when the amount of leverage used by a ﬁrm rises.
A)I and III only.
B)II and IV only.
C)I and II only.
D)III and IV only.
E)I and IV only.

Question

Quizplus · Accepted Answer

Statement I is true according to MM Proposition II with no taxes. Statement II is also true because financial risk is determined by the debt-equity ratio. However, Statement III is false, as financial risk does not directly determine the return on assets, but rather can affect it indirectly by changing the cost of capital. Statement IV is also false; the cost of equity actually increases as the amount of leverage used by a firm rises, due to increased financial risk.

Which of the Following Statements Are Correct in Relation to MM