Which of the following statements concerning capital structure theory is false?
ID: 2732904 • Letter: W
Question
Which of the following statements concerning capital structure theory is false?
Under MM with corporate taxes, the value of the levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt.
Under MM with zero taxes, financial leverage raises the firm value and lowers the firm’s WACC.
Under MM with corporate taxes, risk and cost of equity increase with leverage, and this increase is less than the tax benefits of debt financing up to a certain debt level.
Under MM with zero taxes, the benefit of cheaper debt is offset by the higher risk and cost of equity, and the firm value does not rise with debt.
1.Under MM with corporate taxes, the value of the levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt.
2.Under MM with zero taxes, financial leverage raises the firm value and lowers the firm’s WACC.
3.Under MM with corporate taxes, risk and cost of equity increase with leverage, and this increase is less than the tax benefits of debt financing up to a certain debt level.
4.Under MM with zero taxes, the benefit of cheaper debt is offset by the higher risk and cost of equity, and the firm value does not rise with debt.
Explanation / Answer
Under MM , with zero tax, financial leverage does not change the firm's value as the benefit of cheaper debt is offset by the high cost of equity.
Therefore the satement 2 "Under MM with zero taxes, financial leverage raises the firm value and lowers the firm’s WACC." is false.
All the other statement are correct as per MM theory.
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