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