Question

Which one of these events might cause the biggest challenge to the MM propositions?

O A new law requiring equal lending rates for all borrowers

O An increase in a firm's unlevered WACC

O A decrease in the cost of debt

O A change in tax laws to treat interest and dividends equally

O An increase in the corporate tax rates

Answer 1

MM propositions assumes an economic scenario where tax rate is zero. company can choose any type of capital in capital straucture and it does not affect cost of capital of firm. under proposition II,the theory assumes a tax scenario where company can take benefit of interest payment as tax deduction.

An increase in a firm's unlevered WACC might cause the biggest challenge to the MM propositions. this is because when unlevered WACC is increasing it mean risk level of investment in company without using debt is increasing.

Option (B) is correct answer,