According to MM II,if the expected return on assets decreases,what happens to the expected return on equity?
A) Depends on the firm's capital structure
B) Decreases
C) Stays constant
D) Increases

Question

Quizplus · Accepted Answer

According to MM II (Modigliani-Miller theorem), the expected return on equity is dependent on the firm's capital structure. However, in a world with no taxes or other market frictions, MM II states that the expected return on equity is equal to the risk-free rate plus a premium proportional to the company's leverage. Thus, if the expected return on assets decreases (i.e., the risk-free rate decreases or the market risk premium decreases), the expected return on equity will also decrease proportionally. Therefore, the correct answer is B: Decreases.

According to MM II,if the Expected Return on Assets Decreases,what