Under MM Proposition II with no taxes, the WACC is invariant to the debt-equity ratio because Blank______.Multiple choice question.the return on assets (RO) is lowerthe return on debt (RD) remains constantthe return on debt (RD) declinesthe return on assets (RO) is unchanged
Question
Under MM Proposition II with no taxes, the WACC is invariant to the debt-equity ratio because Blank______.Multiple choice question.the return on assets (RO) is lowerthe return on debt (RD) remains constantthe return on debt (RD) declinesthe return on assets (RO) is unchanged
Solution
The correct answer is "the return on assets (RO) is unchanged".
Under Modigliani-Miller Proposition II with no taxes, the Weighted Average Cost of Capital (WACC) is invariant to the debt-equity ratio because the return on assets (RO) is unchanged. This proposition assumes that the total value of a firm is not affected by its capital structure and that the firm's cost of equity increases linearly as a function of its debt-equity ratio. However, the overall cost of capital (WACC) remains constant because the increase in the cost of equity exactly offsets the benefit of additional debt.
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