The reason that MM Proposition I does not hold in the presence of corporate taxation is because:
A)bondholders require higher rates of return compared with stockholders.
B)levered firms pay less taxes compared with identical unlevered firms.
C)dividends are no longer relevant with taxes.
D)earnings per share are no longer relevant with taxes.
E)All of the above.

Question

Quizplus · Accepted Answer

MM Proposition I states that the value of a firm is independent of its capital structure. However, when corporate taxation is considered, the proposition does not hold as levered firms pay less taxes compared with identical unlevered firms. This tax advantage of debt increases the value of the firm and affects its cost of capital. Therefore, choice B is the correct answer. Choices A, C, and D are incorrect as they do not provide a valid explanation for why MM Proposition I does not hold with corporate taxation.

The Reason That MM Proposition I Does Not Hold in the Presence