Question

A key underlying assumption of MM Proposition I without taxes is that: corporations are all-equity financed. individuals can borrow at lower rates than corporations. individuals and corporations borrow at the same rate. financial leverage increases risk. managers always act to maximize the value of the firm. True or false?

Answer 1

Answer:

C.  Individuals and corporations borrow at the same rate.

Revised Question:

A key underlying assumption of MM Proposition I without taxes is that:

A.  financial leverage increases risk.

B.  individuals can borrow at lower rates than corporations.

C.  individuals and corporations borrow at the same rate.

D.  managers always act to maximize the value of the firm.

E.  corporations are all-equity financed.

Explanation:

Modigilani-Miller gave theories about the optimal capital structure of the firms. They proposed thier theories under taxes and and without taxes economies. They gave two propositions under each economy.

MM proposition I without taxes states that value of of firm with equity finance and value of a firm with debt finance are equal. So the capital structure of a firm is irrelevant in decision making.

The underlying assumption of the proposition is:

Presence of asymmetric information due to which, investor's and firm's cost of borrowing money is same.