Suppose Consumption Is $7,500 When Income Is $4,000 and the MPS

question 205

Multiple Choice

Suppose consumption is $7,500 when income is $4,000 and the MPS equals 0.4. When income increases to $6,000, consumption is

• A) $8,050.
• B) $8,300.
• C) $8,700.
• D) $9,500.

---

Definitions:

Trade-Off Theory

The addition of financial distress and agency costs to either the MM tax model or the Miller model. When trade-off is added to either model, the optimal capital structure can be visualized as a trade-off between the benefit of debt (the interest tax shield) and the costs of debt (financial distress and agency costs).

Debt Financing

A method of funding in which a company raises capital by borrowing money, agreeing to repay the principal amount along with interest on a specified schedule.

MM Model

The Modigliani-Miller theorem, proposing that in perfect markets, the value of a firm is unaffected by its capital structure.

Miller Model

A model formulated by Merton Miller, part of the Modigliani-Miller theorem, which discusses the irrelevance of capital structure for a company's market value under certain assumptions.