The "Pure Modigliani and Miller Result" establishes,under restrictive assumptions,that the firm's stock price will be maximized if it uses virtually 100 percent debt.Which of the following real world conditions does the most to limit real world corporate debt-to-assets ratios to far less than 100 percent?
A) There are brokerage costs.
B) At high levels of debt revenues decline.
C) Investors can't really borrow at the same rate as corporations.
D) Interest rates increase as the debt-to-assets ratio rises.
E) Dividends are relevant in the real world.

Question

Quizplus · Accepted Answer

The "Pure Modigliani and Miller Result" assumes no taxes, bankruptcy costs, or effects on business risk as debt increases. However, in the real world, as a firm increases its debt-to-assets ratio, lenders perceive higher risk of default and thus demand higher interest rates to compensate for this risk. This increased cost of debt at higher levels of leverage limits the practicality of firms financing themselves with close to 100 percent debt.

The "Pure Modigliani and Miller Result" Establishes,under Restrictive Assumptions,that the Firm's