The proposition that the cost of equity is a positive linear function of capital structure is called:
A) The Capital Asset Pricing Model.
B) M&M Proposition I.
C) M&M Proposition II.
D) The Law of One Price.
E) The Eﬃcient Markets Hypothesis.

Question

Quizplus · Accepted Answer

M&M Proposition II states that the cost of equity is a positive linear function of the firm's debt-to-equity ratio. This proposition shows that as the leverage or debt of a company increases, the risk to equity holders also increases. Therefore, they require a higher return on their investment, which leads to an increase in the cost of equity capital.

The Proposition That the Cost of Equity Is a Positive