Question

According to Modigliani and Miller (MM), in a world without taxes, the optimal capital structure for a for-profit business calls for approximately 100 percent debt financing.

True

False

Answer 1

Answer - False.

According to Modigliani and Miller proposition, without taxes, no matter how the firm borrows, there will be no tax benefit from interest payments and thus no changes or benefits to the WACC. This implies, the tax benefit that interest harbors for debt would be lost and there would be no differentiation in terms of cost for any form of capital - debt or equity.

This means any change in capital structure would still have the WACC at same levels.

So, MM proposition without taxes is basically indifferent between debt and equity forms of financing