The proposition that the cost of equity is a positive linear function of capital structure is called:
A) the capital asset pricing model.
B) MM Proposition I.
C) MM Proposition II.
D) the law of one price.
E) the efficient markets hypothesis.

Question

Quizplus · Accepted Answer

MM Proposition II states that the cost of equity is a positive linear function of capital structure, meaning that as a firm increases its reliance on debt financing (and thus increases its financial risk), the cost of equity also increases due to the increased required return to compensate for the higher level of risk. The other answer choices are theories and concepts in finance, but do not specifically address this relationship between cost of equity and capital structure.

The Proposition That the Cost of Equity Is a Positive