In the Modigliani & Miller model of capital structure,with no corporate taxes,as a firm increases the D/V ratio,the cost of equity also increases.

Question

Quizplus · Accepted Answer

In the Modigliani & Miller model of capital structure, it is assumed that there are no corporate taxes. In this scenario, as a firm increases the proportion of debt in its capital structure (D/V ratio), the overall cost of capital (WACC) does not change. However, since debt is a cheaper source of financing compared to equity, increasing the D/V ratio also increases the financial risk of the firm. This increased risk will lead to a higher cost of equity, as investors will demand a higher return to compensate for the higher risk of the firm's shares. Thus, the statement that "as a firm increases the D/V ratio, the cost of equity also increases" is true in this model.

In the Modigliani & Miller Model of Capital Structure,with No