MM Proposition I with taxes supports the theory that: (a) a firm\'s weighted ave

Question

MM Proposition I with taxes supports the theory that:

(a) a firm's weighted average cost of capital increases as the debt-equity ratio of the firm rises.

(b) there is a positive linear relationship between the amount of debt in a levered firm and its value. the value of a firm is inversely related to the amount of leverage used by the firm.

(c) the value of an unlevered firm is equal to the value of a levered firm plus the value of the interest tax shield.

(d) a firm's cost of capital is the same regardless of the mix of debt and equity used by the firm.

Explanation / Answer

Option "B" is the correct option, i.e., there is a positive linear relationship between the amount of debt in a levered firm and its value. the value of a firm is inversely related to the amount of leverage used by the firm. Basically, it means that the firm with the greater proportion of debt is more valuable because of the interest tax shield.

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