(based on Exam 2, AM, question 33 - actual question 33 is not exactly that) Statement 1: The cost of equity increases linearly as a company increases its proportion of debt financing. The value of the company with leverage is equal to the value of the company without levrage. Question: Is statement 1 consistent with Modigliani and Miller (MM) propositions? My answer would be NO. Reason: “Proportion of debt financing” is Debt / (Debt + Equity). MM assumption is that cost of equity increases linearly with Debt / Equity - that’s the difference. Though, if you remove the “linearly”, it is true. Sorry, may be I’ve been too far on MM… It’s about 100°F in Munich this afternoon. That explains.
Thinking too deep, man. statement is consistent with ex-taxes MM.
It is closer to the ex-tax MM than to the with-tax MM. Sure. But wrong anyway.
I accept your point, but this is one of those “exam way” issues where you can’t be too clever! Be dumb like me and pick up the mark…