With risky debt and MM II, the expected return on assets _____ as the debt-equity ratio _____.
A) increases; increases
B) decreases; increases
C) increases; decreases
D)remains constant; increases

Question

Quizplus · Accepted Answer

According to Modigliani and Miller Proposition II (with taxes), the expected return on assets remains constant regardless of the debt-equity ratio. This is because the cost of equity increases with leverage to exactly offset the cheaper cost of debt, leaving the overall cost of capital unchanged.

With Risky Debt and MM II, the Expected Return on Assets