M & M Proposition II with taxes:
A)has the same general implications as M & M Proposition II without taxes.
B)states that a firm's capital structure is irrelevant.
C)supports the argument that business risk is determined by the capital structure decision.
D)supports the argument that the cost of equity decreases as the debt-equity ratio increases.
E)concludes that the capital structure decision is irrelevant to the value of a firm.

Question

Quizplus · Accepted Answer

M & M Proposition II with taxes generally implies that the cost of capital decreases as leverage increases, due to the tax shield provided by debt. This is a modification of the original M & M Proposition II without taxes, which suggests that the cost of capital is unaffected by the capital structure. However, both propositions imply that leveraging affects the cost of capital, albeit in opposite directions due to the consideration of taxes.

M & M Proposition II with Taxes