Which of the following is consistent with the original formulation of the Modigliani and Miller Capital Structure Theorem?
A)A firm's composite cost of capital decreases as financial leverage is used.
B)A firm's common stock price falls as financial leverage is used.
C)A firm's composite cost of capital and common stock price are unaffected by the amount of financial leverage used by the firm.
D)A firm's composite cost of capital increases as operating leverage is used.

Question

Quizplus · Accepted Answer

The original Modigliani and Miller Capital Structure Theorem suggests that a firm's composite cost of capital and common stock price are unaffected by the amount of financial leverage used by the firm. This is under the assumption that there are no taxes, no bankruptcy costs, no agency costs, and no asymmetric information. Therefore, option C is the correct choice as it is consistent with the original formulation of the theorem. Option A is incorrect as the original theorem suggests that the composite cost of capital is independent of the degree of financial leverage. Option B is also incorrect as the original theorem does not suggest a relationship between financial leverage and the firm's common stock price. Option D is wrong as the original theorem only considers the impact of financial leverage, not operating leverage.

Which of the Following Is Consistent with the Original Formulation