Which one of the following statements concerning ﬁnancial leverage is correct in a world without taxes?
A) Leverage is beneﬁcial only when EBIT is relatively low.
B) EPS is decreased when leverage is used and the expected level of EBIT is achieved.
C) Financial leverage lowers the risk level of a ﬁrm.
D) The amount of ﬁnancial leverage employed has a major effect on the value of the ﬁrm.
E) M&M Proposition I states that ﬁnancial leverage is irrelevant to the value of a ﬁrm.

Question

Quizplus · Accepted Answer

M&M Proposition I states that in a world without taxes, financial leverage is irrelevant to the value of a firm. Therefore, none of the other statements are correct. Choice A is incorrect because leverage can be beneficial regardless of the level of EBIT, as it can magnify profits as well as losses. Choice B is incorrect because EPS may increase or decrease depending on the level of EBIT and the amount of leverage used. Choice C is incorrect because financial leverage increases the risk level of a firm, as it magnifies both profits and losses. Choice D is incorrect because the amount of financial leverage employed does not affect the value of a firm in a world without taxes, according to M&M Proposition I.

Which One of the Following Statements Concerning ﬁNancial Leverage Is