CFA Level I · CFA Level I Exam · Capital Structure
According to Modigliani-Miller Proposition I without taxes, a firm's value is most likely:
Under Proposition I without taxes, firm value is independent of capital structure. Value is determined by the firm's operating cash flows and business risk, so changing the debt-equity mix only divides the same value differently between debtholders and shareholders and does not create value.
- Aindependent of its capital structureCorrect
- Bmaximized at a high debt-to-equity ratio
- Cmaximized when it uses only equity financing
Explanation
In a world with no taxes, no bankruptcy costs and perfect markets, firm value depends on the cash flows from its assets and their risk, not on how those cash flows are split between debt and equity. The other options describe results that arise only when market imperfections are introduced.
Did you get it right without looking?
One question tells you little. A timed set on Capital Structure shows your real accuracy, how long you take and where you lose marks.
More Capital Structure questions
- Relative to the Modigliani-Miller propositions with corporate taxes, the static trade-off theory most likely concludes that the optimal capi…
- Two firms have identical debt-to-equity ratios and tax rates. Firm X is a software company with mostly intangible assets and volatile earnin…
- A company has a target capital structure of 40% debt and 60% equity. The after-tax cost of debt is 4.5% and the cost of equity is 11.0%. The…
- Compared with a firm with stable cash flows and mostly tangible assets, a firm with volatile cash flows and mostly intangible assets is most…
- Compared with the static trade-off theory's prediction at the optimal capital structure, a firm that has raised debt well beyond that optimu…
- According to the static trade-off theory of capital structure, the optimal level of debt for a firm is most likely reached at the point wher…