MM's proposition II states that the expected return on equity increases as the firm's debt-equity ratio increases.

Question

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MM's proposition II, also known as the capital structure irrelevance principle, suggests that the overall cost of capital remains constant as the firm's debt-equity ratio changes, but the expected return on equity increases due to the higher financial leverage. This is because the use of debt financing magnifies the potential earnings of equity investors, leading to a higher return on investment.

MM's Proposition II States That the Expected Return on Equity