Problem 1: In a world of no corporate taxes if the use of leverage does not change the value of the levered firm relative to the unlevered firm this is known as:
- MM Proposition III that the cost of stock is less than the cost of debt.
- MM Proposition I that leverage is invariant to market value.
- MM Proposition II that the cost of equity is always constant.
- MM Proposition I that the market value of the firm is invariant to the capital structure.
- MM Proposition III that there is no risk associated with leverage in a no tax world.
Problem 2: The reason that MM Proposition I does not hold in the presence of corporate taxation is because:
- levered firms pay less taxes compared with identical unlevered firms.
- bondholders require higher rates of return compared with stockholders.
- earnings per share are no longer relevant with taxes.
- dividends are no longer relevant with taxes.
- All of the above.