ZuoTi.Pro
Question

The Miller Modigliani theorem posits that debt policy is irrelevant, when it comes to firm value....

The Miller Modigliani theorem posits that debt policy is irrelevant, when it comes to firm value. Assume that you have a firm that is funded entirely with equity and has a beta (unlevered) of 0.90, the risk-free rate is 3% and the equity risk premium is 6%. What will happen to the cost of capital, if the firm moves to a 30% debt ratio?

a.) none is true

b.) the cost of capital will go up

c.) the cost of capital will remain unchnaged

d.) the cost of capital will go down

business   finance   
0 0
Add a comment Improve this question Transcribed image text
Next > < Previous
Sort answers by oldest

Homework Answers

Answer #1

Beta Unlevered =0.90
New debt ratio =30
So debt equity ratio =3/7
when debt policy is irrelevant for firm value .the tax rate =0%
Beta levered =Beta Unlevered*(1+Debt/Equity) =0.90*(1+30/70) =1.2857

Higher the beta, higher is the cost of capital.

Option b is correct.the cost of capital will go up

0 0
Add a comment
Know the answer?
Add Answer to:
The Miller Modigliani theorem posits that debt policy is irrelevant, when it comes to firm value....
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Log In

Sign Up

Not the answer you're looking for? Ask your own homework help question. Our experts will answer your question WITHIN MINUTES for Free.
Similar Homework Help Questions

  • According to the Modigliani and Miller​ hypothesis, the value of a​ firm:  ​(Selct the best choice​...

    According to the Modigliani and Miller​ hypothesis, the value of a​ firm:  ​(Selct the best choice​ below.) A. is independent of the​ firm's capital structure. B. is maximized as the firm uses​ 99.9% of equity financing in its capital structure. C. decreases as the debt financing in the​ firm's capital structure increases. D. increases as the debt financing in the​ firm's capital structure increases.

  • The Modigliani-Miller theory that the value of the firm is independent of its capital structure is...

    The Modigliani-Miller theory that the value of the firm is independent of its capital structure is based on a(n) process. Reinvestment Capital asset pricing model Arbitraging Compound interest Question 2 As more debt is added to the capital structure of a firm, the cost of debt capital initially rises slowly, then falls beyond some point increases at a steady rate throughout the entire range becomes greater than the cost of equity beyond a certain point initially rises slowly, then increases...

  • 2. Which of the following statement is true regarding the Modigliani and Miller (M&M) propositions (1958)...

    2. Which of the following statement is true regarding the Modigliani and Miller (M&M) propositions (1958) in a perfect financial market? A) Capital structure is irrelevant because of the assumption that investors and companies have differing tax rates. B) It is assumed that the firm’s future cash flows remain fixed under any circumstances. C) The basic lesson of M&M propositions is that company’s capital budgeting decisions are dependent upon the company's capital structure decision. D) The debt-to-equity ratio is an...

  • You are given the following data on the balance sheet of a company: Assets 455,000 Debt...

    You are given the following data on the balance sheet of a company: Assets 455,000 Debt 155,000 Equity 300,000 Total assets 455,000 Total liabilities 455,000 The cost of debt capital is 4% and the cost of equity is 13%. The risk free rate is 3% and the expected return on the market index is 7%. What is the weighted average cost of capital for the company? What is the beta of the assets of the company? Suppose the firm changes...

  • In their iconic 1958 paper, Miller and Modigliani assume a perfect world and then show that...

    In their iconic 1958 paper, Miller and Modigliani assume a perfect world and then show that the way a firm finances its assets (debt, equity, or some combination) is irrelevant. To create this perfect world, they make 4 assumptions: 1) capital markets are perfect; 2) all information is symmetric; 3) investment strategy is not affected by a firm’s cash flows; 4) investor and firms can borrow at the same terms. Which two of these assumptions are important to the theory...

  • A firm has the following capital structure: £100 million of equity (market value) with 100 million...

    A firm has the following capital structure: £100 million of equity (market value) with 100 million shares outstanding, and £100 million of debt. The beta of the firm’s stock is 1.6. The firm’s cost of equity is 10 percent, and the yield on riskless bonds is 2 percent. There is no tax. Assuming that the firm can borrow at the risk-free rate and that both CAPM (Capital Asset Pricing Model) and the Modigliani-Miller theorem hold, answer the following questions. i)...

  • c) A firm has the following capital structure: £100 million of equity (market value) with 100...

    c) A firm has the following capital structure: £100 million of equity (market value) with 100 million shares outstanding, and £100 million of debt. The beta of the firm’s stock is 1.6. The firm’s cost of equity is 10 percent, and the yield on riskless bonds is 2 percent. There is no tax. Assuming that the firm can borrow at the risk free rate and that both CAPM (Capital Asset Pricing Model) and the Modigliani-Miller theorem hold, answer the following...

  • Which of the following statements is false in a Modigliani-Miller world? A. Capital structure does not...

    Which of the following statements is false in a Modigliani-Miller world? A. Capital structure does not affect the cost of capital B. Higher leverage increase the cost of equity C. Higher leverage does not affect the WACC D. Higher leverage does not affect the cost of equity Which of the following is not an advantage of having large shareholders? A. Better coordination in monitoring management B. Executives more likely to be dismissed when underperforming C. Less shareholders' interference in the...

  • The Miller-Modigliani Arguments Firm U is all-equity financed, while Firm L is both debt- and equity-financed....

    The Miller-Modigliani Arguments Firm U is all-equity financed, while Firm L is both debt- and equity-financed. The following table gives some relevant data on the two firms: (No Taxes)                                                                                                 Firm U Firm L Annual expected future cash flow $5 M $5 M Cost of equity (rE) 15% 16% Market value of debt (D) 0 $15 M Cost of debt (rD) N/A 12% Market value of equity (E) ? ? Market value of the firm (V) ? ? Weighted average...

  • A firm has the following capital structure: 100 million shares outstanding, trading at £1.5 per share,...

    A firm has the following capital structure: 100 million shares outstanding, trading at £1.5 per share, and £100 million of debt. The beta of the firm’s stock is 1.5. The firm’s cost of equity is 10 percent, and the yield on riskless bonds is 2.5 percent. There is no tax. Assuming that the firm can borrow at the risk free rate and that both CAPM (Capital Asset Pricing Model) and the Modigliani-Miller theorem hold, answer the following questions. i) What...

ADVERTISEMENT
Free Homework Help App
Download From Google Play
Scan Your Homework
to Get Instant Free Answers
Need Online Homework Help?
Ask a Question
Get Answers For Free
Most questions answered within 3 hours.
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT