The Modigliani and Miller hypothesis does NOT work in the "real world" because
A) interest expense is tax deductible, providing an advantage to debt financing.
B) higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real costs for any corporation.
C) dividend payments are fixed and tax deductible for the corporation.
D) both A and B

Question

Quizplus · Accepted Answer

The Modigliani and Miller hypothesis assumes that in a perfect world, the capital structure of a firm does not affect its value. However, in the real world, both interest expense being tax deductible (advantage to debt financing) and higher levels of debt increasing the likelihood of bankruptcy (real costs for any corporation) provide evidence to the contrary. Therefore, both A and B are true and the hypothesis does not work in the real world.

The Modigliani and Miller Hypothesis Does NOT Work in the "Real