Question
Why is MM's assertion about the positive relationship between firm value and leverage not observed in the real world?
Multiple choice question.
MM did not consider dividend costs.
MM did not consider the debt tax shield.
MM did not consider bankruptcy costs.
Multiple choice question.
MM did not consider dividend costs.
MM did not consider the debt tax shield.
MM did not consider bankruptcy costs.
Answers
GPT-4o mini
The correct answer is:
**MM did not consider bankruptcy costs.**
In their original capital structure theory (Modigliani and Miller Proposition I and II), they made certain assumptions, including the absence of bankruptcy costs. In reality, as a firm takes on more leverage (debt), the risk of bankruptcy increases, which can negatively impact firm value. This contrasts with their theoretical assertion that firm value is independent of capital structure under certain conditions.
**MM did not consider bankruptcy costs.**
In their original capital structure theory (Modigliani and Miller Proposition I and II), they made certain assumptions, including the absence of bankruptcy costs. In reality, as a firm takes on more leverage (debt), the risk of bankruptcy increases, which can negatively impact firm value. This contrasts with their theoretical assertion that firm value is independent of capital structure under certain conditions.