Series 79 practice questionmediumCapital Structure Theory
According to the Modigliani-Miller theorem with corporate taxes, what is the effect of increasing leverage on a firm’s value?
- AFirm value increases with leverage due to the interest tax shield.✓ Correct answer
- BFirm value decreases as leverage increases.
- CFirm value remains unchanged regardless of leverage.
- DFirm value increases only if new equity is issued.
Explanation
Why A — Firm value increases with leverage due to the interest tax shield.
With corporate taxes, Modigliani-Miller shows that more debt increases firm value due to the tax deductibility of interest. Without taxes, firm value is independent of leverage.
Turn it into reps
Reading one answer is not the same as being ready
Lucky the Banker is a free practice app with 995+ Series 79 questions, weak-area tracking, and timed mock exams. No credit card, no paywall.
Spot an error in this question or explanation? Tell us — we fix these fast.
Related Collection, Analysis & Evaluation of Data questions
- When calculating WACC, why is it preferable to use market values rather than book values for debt and equity?
- An investment banker is helping a client determine its optimal capital structure. Which of the following is most likely…
- Which of the following best describes the impact of convertible debt on a company’s capital structure?
- Assume the risk-free rate is 3%, market risk premium is 6%, and a company’s beta is 1.5. What is the company’s cost of…
- A company’s EBITDA is $30 million and annual interest expense is $6 million. What is its interest coverage ratio?
- A company increases its debt-to-total capitalization ratio from 30% to 50%. Assuming the after-tax cost of debt is less…
- If a company issues $100 million of bonds at a yield of 6%, and the corporate tax rate is 25%, what is the company’s…
- Which of the following statements is true regarding the impact of a higher proportion of debt in a company’s capital…