Question

4. MM Proposition I with corporate taxes states that:
   1. capital structure can affect firm value.
   2. by raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value.
   3. firm value is maximized at an all-equity capital structure.
   4. all of the above.
   5. both A and B.

Answer 1

Answer (b) by raising the debt to equity ratio the firm can lower it's taxes an thereby increase its total value

The Modigliani-Miller theorem (MM) Proposition I claims that the firm.'s capital structure cannot affect it's value.The value of the company is determined by present value of future cash flows.The MM Proposition I (first proposition) Value of a leveraged company =Value unlevered +tax rate * debt.The First proposition indicates that the tax shields from tax deductible (interest payments ) help increase the value of the company,So increasing the debt equity ratio would imply higher debt and higher tax deductions and as a result the total value increases.

other options explained

a)capital structure can affect firm value

false .The Modigliani-Miller theorem (MM) Proposition I claims that the firm.'s capital structure cannot affect it's value

c) Firm value is maximized at an all equity capital structure.

false Since the presence of debt payments actually make the value of leveraged firm(debt +equity) higher than unlevered firm(all equity)

d)All of the above

False.Since some of them are not true.

e)Both A and B

False Since the firm's capital structure cannot affect it's value