The fact that interest payments on debt are tax deductible is a key factor in which of these propositions?
A)Both MM Proposition I and II,with taxes
B)MM Proposition I,without tax
C)MM Proposition II,without tax
D)MM Proposition I,with tax
E)MM Proposition II,with tax

Question

Quizplus · Accepted Answer

MM Proposition I states that the value of a levered firm is equal to the value of an unlevered firm plus the present value of tax savings from debt. MM Proposition II states that the cost of equity for a levered firm is greater than the cost of equity for an unlevered firm. The fact that interest payments on debt are tax deductible is a key factor in both of these propositions because it reduces the cost of debt and, therefore, increases the value of the levered firm and the cost of equity for the levered firm.

The Fact That Interest Payments on Debt Are Tax Deductible