MM Proposition II states that
I.the expected return on equity is positively related to leverage;
II.the required return on equity is a linear function of the firm's debt to equity ratio;
III.the risk to equity increases with leverage
A)I only
B)II only
C)III only
D)I, II, and III

Question

Quizplus · Accepted Answer

MM Proposition II posits that the expected return on equity increases with leverage because equity becomes riskier as debt increases. This is because the cost of equity is a linear function of the company's debt-to-equity ratio, reflecting the increased risk to equity holders as leverage rises. Thus, all three statements are correct interpretations of MM Proposition II.

MM Proposition II States That