Question

4From what we know about the Modigliani-Miller propositions, if we decrease the corporate tax rate, then firms should use more debt relative to equity financing.

True / False

Answer #1

False.

Modigliani-Millerpropsotions are based on the key assumptions:

- No taxes
- No transaction costs
- No bankruptcy costs
- Equivalence in borrowing costs for both companies and investors
- Symmetry of market information, meaning companies and investors have the same information
- No effect of debt on a company's earnings before interest and taxes

So, according to Modigliani Miller Proposition of 'Capital
Structure Irrelevance", the weighted average cost of capital (WACC)
should remain constant with changes in the company's capital
structure and since there are no tax or tax benefits for interest
payments, whether you take debt or equity, per MM proposition, it
would not impact your business

According to Modigliani and Miller (1963 which allows for the
presence of the corporate taxes), which of the following is/are
true?
a. an increase in the corporate tax rate will increase the value
of the debt tax shield, ceteris paribus (holding all else
constant)
b. firms will maximize value as the D/TA ratio approaches
100%
c. WACC continues to decrease as we use more and more debt
d. only a & b are correct
e. a, b, and c are...

Answer the problem based on the framework of Modigliani and
Miller Propositions. Assume that a company has earnings before
interest and taxes (EBIT) of $1,000,000 every year forever. The
firm also has perpetual bonds with the market value of $2,000,000.
The before-tax cost of debt is 8 percent. The firm’s unlevered cost
of capital is 15 percent. The tax rate is 25 percent.
a) Find the value of the firm.
b) Find the value of equity.
c) Find the firm’s...

Which of the following statement is true regarding the
Modigliani and Miller (M&M) propositions (1958) in a perfect
financial market?
A) Capital structure is irrelevant because of the assumption
that investors and companies have differing tax rates.
B) It is assumed that the firm’s future cash flows remain fixed
under any circumstances.
C) The basic lesson of M&M propositions is that company’s
capital budgeting decisions are dependent upon the company's
capital structure decision.
D) The debt-to-equity ratio is an important...

A company is about to undertake a new project. In a Modigliani
and Miller world with only tax, the cash flows are given as
following.
1. year
2. year
3. year
4. year
5. year
10
10
10
10
10
Risk free rate =3%, cost of debt = 6% and return on equity =15%.
The CEO calculated NPV as 0. Thus, he is indifferent in terms of
undertaking the project and does not know what to do. When you
checked...

A company is about to undertake a new project. In a Modigliani
and Miller world with only tax, the cash flows are given as
following.
1. year
2. year
3. year
4. year
5. year
10
10
10
10
10
Risk free rate =3%, cost of debt = 6% and return on equity =15%.
The CEO calculated NPV as 0. Thus, he is indifferent in terms of
undertaking the project and does not know what to do. When you
checked...

A company is about to undertake a new project. In a Modigliani
and Miller world with only tax, the cash flows are given as
following.
1. year
2. year
3. year
4. year
5. year
10
10
10
10
10
Risk free rate =3%, cost of debt = 6% and return on equity =15%.
The CEO calculated NPV as 0. Thus, he is indifferent in terms of
undertaking the project and does not know what to do. When you
checked...

2. Firm value and capital structure in the absence of tax.
Assume a zero corporate tax rate. Because both the risk of a firm’s
equity and debt increase with debt financing, then the value of the
firm should decrease when it uses more and more debt. True or
false?

2. Firm value and capital structure in the absence of tax.
Assume a zero corporate tax rate. Because both the risk of a firm’s
equity and debt increase with debt financing, then the value of the
firm should decrease when it uses more and more debt. True or
false?

1- Under the theory of Modigliani & Miller without taxes,
which of the following statements is false?
a) The capital structure is irrelevant.
b) The cost of equity is a linear function of the equity-to-debt
ratio.
c) The value of the levered company is equal to the value of the
unlevered company.
d) The cost of equity increases as the debt-to-equity ratio
increases.
2 - Which of the following statements is true regarding the
pecking order theory?
a) The external...

Which of the following statements is FALSE?
A. Franco Modigliani and Merton Miller argued that with perfect
capital markets, the total value of a firm should not depend on its
capital structure.
B. Because the cash flows of the debt and equity sum to the cash
flows of the project, by the Law of One Price the combined values
of debt and equity must be equal to the cash flows of the
project.
C. Leverage decreases the risk of the...

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