Skip to content

CA Intermediate · Financial Management and Strategic Management · Financing Decisions - Capital Structure

Under the Modigliani-Miller proposition with corporate taxes, an unlevered firm in the same risk class is valued at ₹800 lakh. A similar levered firm has permanent debt of ₹200 lakh and the corporate tax rate is 25%. The value of the levered firm is:

The levered firm is worth ₹850 lakh. Under MM with corporate tax, value equals unlevered value plus the present value of the interest tax shield, which is tax rate times debt: 800 + 25% × 200 = 850. Debt creates value only through the tax shield.

  1. A₹750 lakh
  2. B₹800 lakh
  3. C₹850 lakhCorrect
  4. D₹1,000 lakh

Explanation

With taxes, V(levered) = V(unlevered) + tax rate × Debt = 800 + 0.25 × 200 = ₹850 lakh. The ₹1,000 lakh option wrongly adds the whole debt. ₹800 lakh ignores the tax shield, and ₹750 lakh subtracts it.

Did you get it right without looking?

One question tells you little. A timed set on Financing Decisions - Capital Structure shows your real accuracy, how long you take and where you lose marks.

Practise Financing Decisions - Capital StructureFree diagnostic mock

More Financing Decisions - Capital Structure questions