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John Harrison is discussing the implications for Modigliani and Miller (MM’s) propositions (assuming no corporate or personal taxes) for manager’s decisions regarding capital structure with his supervisor, Harriet Perry. In the conversation, Harrison makes the following statements:
Statement 1: According to MM’s propositions, increasing the use of cheaper debt financing will increase the cost of equity and the net change to the company’s weighted average cost of capital (WACC) will be zero.
Statement 2: Since MM’s propositions assume that there are no taxes, equity is the preferred method of financing.
What is the most appropriate response to Harrison’s statements? A. Agree with both. B. Agree with one only. C. Agree with neither. |