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1. How do the Modigliani and Miller Propositions 1 and 2 change when taxes are considered?...

1. How do the Modigliani and Miller Propositions 1 and 2 change when taxes are considered? Why is there a difference?

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Answer #1

MM1 states WACC ( weighted average cost of capital) is independent of changes in tax . WACC doesnot change with changes in capital structure However MM2 states WACC reduces with increase in tax and increases with reduction in tax. WACC is dependent on capital structure.

This difference is there because MMI states that interest payments are not tax deductible where as MM2 states that interest payments are tax deductible.

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