Economics · Financial Management
Which of the following statements is correct regarding the Modigliani-Miller (M&M) capital structure theory with corporate taxation?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1The optimal capital structure is achieved at a moderate level of gearing where the marginal cost of debt equals the marginal cost of equity.
- 2The value of a geared company is equal to the value of an ungeared company in the same risk class plus the present value of the interest payments.
- 3The Weighted Average Cost of Capital (WACC) decreases linearly as gearing increases because the benefit of the tax shield on debt outweighs the increase in the cost of equity.✓
- 4The cost of equity remains constant as the company increases its gearing levels because the business risk is unchanged.
Correct answer
The Weighted Average Cost of Capital (WACC) decreases linearly as gearing increases because the benefit of the tax shield on debt outweighs the increase in the cost of equity.
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