According to M&M Proposition 2, the cost of a company's equity[Fill in the blank]

Question

BlackTom AI · Accepted Answer

M&M Proposition II shows that the required return on equity rises linearly with leverage: rE = rA + (D/E)·(rA − rD).

1. Relevant knowledge points and concepts
- Modigliani & Miller (M&M) Proposition I (no taxes) says firm value is independent of capital structure.
- Proposition II (no taxes) links equity cost (rE), unlevered cost of capital (rA), debt cost (rD), and the debt-to-equity ratio (D/E).
- Intuition: adding debt increases financial risk to equity holders, so they demand a higher expected return.

2. Complete reasoning process step by step
- Start from the M&M II relationship: rE = rA + (D/E)·(rA − rD).
- rA and rD are assumed constant under the M&M idealized assumptions (no taxes, no bankruptcy costs, perfect markets).
- The second term (D/E)·(rA − rD) is proportional to D/E and to the positive spread (rA − rD) when rA > rD.
- Therefore as D/E increases, the second term increases, so rE increases.

3. Calculations with intermediate steps (numerical example)
- Let rA = 10%, rD = 5%. For D/E = 0.5: rE = 10% + 0.5·(10% − 5%) = 10% + 0.5·5% = 12.5%.
- For D/E = 1: rE = 10% + 1·5% = 15%.
- These show rE rising as D/E rises.

4. Why the correct answer is correct
- The formula demonstrates a direct, positive linear relationship between rE and D/E under M&M Proposition II (no taxes). Equity holders bear more financial risk with more debt, so required return increases proportionally.

5. Why the other options are incorrect
- b (decreases): contradicts the formula and intuition — increased leverage raises equity risk, not lowers it.
- c (increases and then falls): no turning point exists in the linear relation under M&M II.
- d (decreases and then increases): likewise incorrect; there is no initial decrease.

6. Conclusion
- M&M Proposition II implies the cost of equity increases with the debt-to-equity ratio. This matches the provided correct answer: a. increases with the debt-to-equity ratio.

According to M&M Proposition 2, the cost of a company's equity[Fill in the blank]单项选择题

类似问题

The following data are available for Halcyon Industries at several capital structures. Based on this information, what is the firm's optimal capital structure? Debt Equity EPS Stock Price 20% 80% $2.40 $24.00 30% 70% $2.68 $25.80 40% 60% $2.95 $27.10 50% 50% $3.20 $26.50 60% 40% $3.44 $25.20

According to Modigliani and Miller, in a world with no corporate taxes a firm cannot change its total value by altering the proportions of debt and equity in its capital structure.

Which of the following statements best describes the optimal capital structure? The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's ____.

Modigliani and Miller (MM) won Nobel Prizes for their work on capital structure theory.

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