According to MM,leverage may increase expected earnings per share but still leave the share price unchanged because:
A) the firm's operating risk decreases.
B) the number of shares is decreased.
C) the required return on equity increases.
D) the firm is less risky.

Question

Quizplus · Accepted Answer

According to MM, leverage increases the cost of equity, which is the required return on equity. As a result, even though a company's expected earnings per share may increase with leverage, the cost of equity also increases, meaning that the share price may remain unchanged. Therefore, option C is the best answer. Option A, B, and D are incorrect because they do not accurately reflect MM's theory regarding the relationship between leverage and share price.

According to MM,leverage May Increase Expected Earnings Per Share but Still