Which one of the following statements is true?
A) The total value of a ﬁrm decreases as debt is initially added to an all equity ﬁrm, if taxes are considered.
B) The tax shield applies to both debt and equity ﬁnancing.
C) The ideal capital structure minimizes the total tax liability.
D) Capital structure does matter when taxes are included.
E) The general conclusions of M&M Proposition II do not hold when taxes are considered.

Question

Quizplus · Accepted Answer

When taxes are included, the choice of capital structure does matter as it affects the total tax liability. M&M Proposition II assumes no taxes and therefore its conclusions do not hold true when taxes are considered. Option A is incorrect as adding debt can provide a tax shield and increase the overall value of the firm due to the deductibility of interest payments. Option B is incorrect as the tax shield only applies to debt financing. Option C is incorrect as the ideal capital structure maximizes the tax shield and not necessarily minimizes the tax liability.

Which One of the Following Statements Is True