Question

M&M Proposition I with no taxes implies that the:

Multiple Choice:

a. weighted average cost of capital decreases as the debt-equity ratio increases.

b. cost of equity increases as the debt-equity ratio decreases.

c. value of an unlevered company equals the value of a levered company plus the value of the interest tax shield.

d. cost of capital is the same regardless of the debt-equity ratio used

e. value of a company is inversely related to the amount of leverage used by that company.

URGENT

Answer 1

According to the M&M Proposition I with no taxes, the WACC of the company is equal to the cost of equity of a company financed only by equity. Hence it does not vary with the debt/equity ratio. Hence, the answer is D.

M&M Proposition I with no taxes also states that:
1. cost of equity increases as the debt-equity ratio increases.

2. value of an unlevered company equals the value of a levered company. Thus, value of a company is independent of the amount of leverage used by that company.