4. Assumptions of the Modigliani and Miller proposition Aa Aa Modern capital str

Question

4. Assumptions of the Modigliani and Miller proposition Aa Aa Modern capital structure theory, constructed by Modigliani and Miller, began in 1958 and provided a justification for a corporation's use of more and more financial leverage under certain assumptions. CEOs and CFOs were encouraged to accept M&M's theory and put it into practice, especially when the company's spending is high and the risk of servicing its debt is low. As capital markets have evolved, it is critical to understand the context and assumptions under which this model was created. Review the situation and answer the questions that follow: An analyst has graphed the relationship between the expected return on a firm's capital and its debt-equity (D/E) ratio. Her graph follows: RATES OF RETURN (Percent 20 18 16 14 12 10 Equity r Assets Debt 0.5 1.5 DEBT-EQUITY D/E RAT 20

Explanation / Answer

Assuming only one answer is to be selected as there are no multiple check boxes, please find below the answers for your reference:-

a) Cost of equity will always remain higher than cost of debt.

b) VU is not equal to VL because VL is an unlevered company. VU will be equal to VL if both are levered in a tax free environment.

Related Questions

Navigate

• Browse (All)
• Browse 4
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.