Based on the capital structure graph shown in the attachment, select the incorre

Question

Based on the capital structure graph shown in the attachment, select the incorrect statement.

A. The horizontal line labeled A represents M&M’s Irrelevance Theorem without taxes.

B. VU on the Y-axis represents the value of an under-leveraged firm.

C. The positively sloped straight line labeled B indicates that the firm value will keep rising as more leverage is employed (i.e., as the firm uses more and more debt).

D. The curve labeled C indicates that the firm’s value will decrease once it passes the optimal leverage (L*) because the firm would face greater bankruptcy costs and agency costs which would offset the tax advantage of debt.

Explanation / Answer

B. VU on the Y-axis represents the value of an under-leveraged firm.

it is the unleveraged not underleveraged

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