M&M's Proposition II Suggests That in a World of No

question 57

Multiple Choice

M&M's Proposition II suggests that in a world of no taxes and no bankruptcy,________.

• A)no matter what the debt-equity ratio is,the R_a or WACC of the firm increases with debt
• B)the value of the firm is sensitive to the funding choice between debt and equity
• C)in simple terms,as the firm adds more debt to the financing mix,the shareholders require a higher and higher return on equity such that it exactly offsets the use of the cheaper debt
• D)Statements A,B,and C are all incorrect.

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Definitions:

Principal-Agent Problem

A scenario in which there is a conflict of interest between a party that delegates work (principal) and the party that performs the work (agent).

Corporations

Legal entities that are separate from their owners, with the ability to own assets, incur liabilities, and engage in contracts or legal actions.

Corporate Managers

Individuals in charge of managing a corporation's affairs, making strategic decisions, and ensuring operational efficiency.

Corporate Owners

Individuals or entities that legally own one or more shares of stock in a corporation, giving them rights to its assets and profits.