Why Do Modigliani and Miller and the Modernists Believe That

question 40

Multiple Choice

Why do Modigliani and Miller and the Modernists believe that, when taxes are not being considered, the capital structure is irrelevant?

• A) The price of a business's shares are derived as much from rational decisions based on the returns to a company as from irrational ones.
• B) Shareholders will always demand risk compensation equal to the increased returns from borrowing.
• C) Investors, using borrowed funds to purchase shares in unlevered companies, will equalize the value of levered and unlevered companies.
• D) Capital structure is a closed system where companies push to increase debt, and, lenders and shareholders push to reduce it resulting in a predetermined equilibrium.
• E) There will always be sufficient risk adverse, risk neutral and risk seeking investors to invest in a company regardless of the proportion of debt in its capital structure.

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Definitions:

Hypothesis

A proposed explanation made on the basis of limited evidence as a starting point for further investigation.

Pooled Standard Error

A method to estimate the standard error across two or more samples by combining the individual standard deviations into a single measure, often used in t-tests.

Confidence Interval

A variety of values obtained from sample data that probably encompasses the value of an unspecified population characteristic.

Margin of Error

An expression of the amount of random sampling error in a survey’s results.