MM

CFA Level II
#1

Modigliani and Miller demonstrated that if corporate taxes and bankruptcy costs are introduced into an otherwise perfect world the weighted average cost of capital (WACC) will: A) rise, then plateau, and finally start to fall. B) fall, then bottom out, and finally start to rise. C) fall continuously as more debt is added to the capital structure. D) not change across the various levels of debt in the capital structure.

#2

I’ll post the answer in 10 minutes.

#3

A: Describing the shape of Static Trade Off Theory B: Right C: Would be true I guess under no bankruptcy (MM with taxes, use max debt) D: Would be true for MM without taxes.

#4

B?

#5

I’ll take C

#6

B no question.

#7

B, with my boy Nib, although I don’t get why A is describing the static trade off theory.

#8

B - fall with increased debt due to tax shield, but eventually rise due to costs of financial distress.

#9

Anish - C is when there is no bankruptcy cost, so you keep on adding debt and keep winning on the tax shield received. Static Trade off is when the cost of distress starts to overweigh the tax shield gain received and hence the RISE of the WACC.

#10

It’s B. Basically, the cost of financial distress becomes greater the more debt is added to the structure. That would cause WACC to go up after it comes down thanks to the tax shield.

#11

I’m pretty sure A is describing the shape of the Static Trade Off Theory. I forget what is on each axis, but I think firm value is on the Y axis and the amount of debt is on the X axis. Firm value increases up to the point where the marginal benefit of the tax shield = the marginal cost of the debt, after that firm value decreases. Don’t quote me on this though.

#12

The two year anniversary of my relationship with AF is 1 day before the L2 exam. Should I bring flowers?

#13

Booze and condom’s will be fine.

#14

I just completed 1 year at AF :slight_smile:

#15

5 months for AF, 7 months for my CFA adventure.

#16

dinesh.sundrani Wrote: ------------------------------------------------------- > I just completed 1 year at AF :slight_smile: You have over 2300 posts in one year. That’s crazy!

#17

I was a active poster at L1, became a lurker at L2. Sorry could not keep up to the expectations of the forum.

#18

B

#19

dinesh.sundrani Wrote: ------------------------------------------------------- > I was a active poster at L1, became a lurker at > L2. > > Sorry could not keep up to the expectations of the > forum. Same here. 70% of my posts are from L1.