Assuming no corporate taxes, the independence hypthesis suggets that a firms wei

Question

Assuming no corporate taxes, the independence hypthesis suggets that a firms weighted average cost of capital will

A) Remain constant regardless of capital structures because the cost of debt and the cost of equity are the same

B) Remain constant because the cost of equity will be increasing as the amount of debt increases due to the increased risk.

C) Increase proportionally with the increase in the amount of debt a firm uses

D) Decrease proportionally with the increase in the amount of debt a firm uses

Explanation / Answer

M&M Porposition with no taxes states that the value of the firm does not depend on its capital structure.According to M&M Proposition, it is irrelant of the debt-equity mix. Whatever the weights of debt and equity, but the value of the firm does not change. M&M Porposition with no taxes says how the debt and equity structured in a corporation is irrelevant. The value of the firm is determined by Real assets and not its capital structure. Therefore, the WACC remains constant regardless of capital structure because the cost of debt and cost of equity are the same. The correct option is A)

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