According to MM, if we ignore bankruptcy costs, an increase in financial leverage can increase the value of the firm:
A)in a world without taxes.
B)if interest is tax-deductible.
C)if interest is not tax-deductible.
D)a and b
E)All of the above

Question

Quizplus · Accepted Answer

According to Modigliani and Miller (MM), an increase in financial leverage can increase the value of the firm in a world with taxes if interest is tax-deductible. This is because the interest paid on debt is tax-deductible, which reduces the firm's taxable income and hence reduces the amount of taxes paid. This increase in cash flows to the firm increases its value. However, if interest is not tax-deductible, then an increase in financial leverage will not increase the value of the firm. In a world without taxes, an increase in financial leverage will also not increase the value of the firm as bankruptcy costs are ignored.

According to MM, If We Ignore Bankruptcy Costs, an Increase