Question

Which of the following statements are correct in relation to Modigliani and Miller’s propositions in a frictionless perfect capital market? A. The required return on assets is equal to the weighted average cost of capital. B. The risk of a firm’s equity is determined by the debt-equity (D/E) ratio. C. A firm’s cost of equity is a linear function of the debt-equity (D/E) ratio. D. The cost of equity declines when the amount of leverage used by a firm rises. E. The debt-equity ratio of a firm is completely irrelevant for overall firm value. F. It is impossible for investors to create homemade leverage that replicates the firm’s leverage

Group of answer choices

A, B, C, and D only

A, B, C, and E only

B, C, D, and E only

B, C, E, and F only

Answer 1

The correct options are

A.) The required return on asset is the weighted average cost of capital.

B.) The risk of a firm does increase as leverage increase.

C.) A firm cost of equity is a linear function of the debt to equity ratio.

E). According to the MM theory, debt-equity ratio does not affect the value of firm.

D is not correct. The cost of equity does not decline when the leverage used by a firm increase. The cost increases. F is also not correct. The investor can create a homemade leverage that replicates the firm leverage.