Why does MM Proposition I not hold in the presence of corporate taxes?
A)Levered firms pay lower taxes when compared with identical unlevered firms.
B)Bondholders require higher rates of return compared with stockholders.
C)Earnings per share are no longer relevant with taxes.
D)Dividends are no longer relevant with taxes.

Question

Quizplus · Accepted Answer

MM Proposition I states that the value of a firm is independent of its capital structure. However, this only holds true in the absence of taxes. In the presence of corporate taxes, levered firms pay lower taxes compared to identical unlevered firms because interest payments are tax-deductible. This tax advantage leads to a debt-equity tradeoff, which affects the value of the firm. Therefore, choice A is the correct answer. Choices B, C, and D are incorrect because they do not directly relate to MM Proposition I and taxes.

Why Does MM Proposition I Not Hold in the Presence