Two prominent finance researchers (Modigliani and Miller) showed that
A)the firm's optimal capital structure consists of approximately equal proportions of debt and equity
B)the value of the firm is independent of its capital structure in perfect capital markets with no income taxes
C)the firm's cost of capital is minimized when its capital structure consists of approximately equal proportions of debt and equity
D)the firm's cost of capital is maximized when its capital structure consists of approximately equal proportions of debt and equity

Question

Quizplus · Accepted Answer

Modigliani and Miller (M&M) showed that, under perfect capital markets with no income taxes, the value of the firm is independent of its capital structure. This is known as the "irrelevance proposition" or the "M&M theorem." This means that the firm's cost of capital is also independent of its capital structure under these conditions. M&M argued that this result holds because investors can replicate the cash flows from a levered firm by investing in an unlevered firm and borrowing at the same rate as the levered firm. Therefore, the choice of capital structure does not affect the total value available to investors, only the way that value is divided between them. However, if there are taxes, bankruptcy costs, or other imperfections in the market, then the optimal capital structure and the firm's cost of capital can be affected.

Two Prominent Finance Researchers (Modigliani and Miller) Showed That