The MM theory with taxes implies that firms should issue maximum debt.In practice,this does not occur because:
A)debt is more risky than equity.
B)bankruptcy is a disadvantage to debt.
C)the weighted average cost of capital is inversely related to the debt-equity ratio.
D)the weighted average cost of capital is directly related to the debt-equity ratio.
E)U.S.regulations require the debt-equity ratio of publicly-traded firms to be in the range of .3 to .7.

Question

Quizplus · Accepted Answer

The MM theory assumes that bankruptcy is without cost and that the tax benefits of debt are fully available. In practice, bankruptcy can be a disadvantage to debt, and the tax benefits of debt may be restricted or non-existent due to various factors such as interest rate caps, alternative minimum tax, and thin capitalization rules. As a result, firms may not issue maximum debt as predicted by the MM theory.

The MM Theory with Taxes Implies That Firms Should Issue