M&M Proposition II with no tax states that a ﬁrm's cost of equity is dependent upon the ﬁrm's cost of
debt ﬁnancing.

Question

Quizplus · Accepted Answer

M&M Proposition II states that a firm's cost of equity is equal to the risk-free rate plus a premium based on the firm's leverage, or the ratio of debt to equity financing. This premium is equal to the cost of debt multiplied by one minus the corporate tax rate. Therefore, the cost of equity is dependent upon the cost of debt financing.

M&M Proposition II with No Tax States That a ﬁRm's