The fact that interest payments on debt are tax deductible is a key factor in which of these propositions?
A)Both MM Proposition I and II,with taxes
B)MM Proposition I,without tax
C)MM Proposition II,without tax
D)MM Proposition I,with tax
E)MM Proposition II,with tax

Question

Quizplus · Accepted Answer

Interest payments on debt are tax deductible, which means that they can be subtracted from taxable income. This reduces the amount of taxes that a company has to pay. MM Proposition I states that the value of a firm is independent of its capital structure. This is because the tax savings from debt financing are offset by the increased risk of bankruptcy. MM Proposition II states that the cost of equity is higher for firms with more debt. This is because investors require a higher return to compensate for the increased risk.

The Fact That Interest Payments on Debt Are Tax Deductible