Question

According to the Modigliani-Miller theorem, which of the following would have to be true in order for capital structure to have no impact upon firm value?

I. Taxes have an impact upon the firm's earnings
II. The risk of defaulting on debt is nonexistent
III. There are no transaction costs of moving from one capital structure to another

Select one:

A. I only

B. I and II only

C. I and III only

D. II and III only

E. I, II, and III

In what ways might a firm seek to benefit its stockholders at the expense of its existing bondholders?

I. By accepting riskier investment projects
II. By paying lower dividends to shareholders
III. By increasing the firm's financial leverage

Select one:

A. I only

B. I and II only

C. I and III only

D. II and III only

E. I, II, and III

Answer 1

1.

option C.

According to MM theory,taxes has no impact on capital structure.Transaction cost also has no impact ,effect of debt has no impact ,bankruptcy cost also has no impact.

2.

Take the money from bond investors and invest in riskier projects which might gives supernormal profit.When investing in riskier projects,stock holders demand high return but bond holders retun is fixes initially.So,shareholders have an opportunity to earn high return.Also increasing the leverage i.e., debt makes shareholders demands high return from the company.Less Dividend payment does not make shareholders wealthy according to modiliani and miller theory as investor wants 100 % payout.So option C