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Answer: Replacing equity with lower-cost debt does not alter the overall weighted average cost of capital.
**Explanation:** Modigliani and Miller's Proposition II without taxes states that substituting equity with lower-cost debt capital does not change the overall weighted average cost of capital (WACC). This is because the reduction in cost due to cheaper debt is exactly offset by an increase in the cost of equity, leaving the WACC unchanged. - **Option A** is incorrect because Modigliani and Miller assumed no cost to bankruptcy, not that the cost is high. - **Option B** is incorrect because the cost of equity is a linear function of the debt-to-equity ratio, not the debt-to-assets ratio. This aligns with the principles of capital structure under the Modigliani-Miller framework.
Author: LeetQuiz Editorial Team
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According to Modigliani and Miller's Proposition II without taxes, which of the following statements is accurate?
A
The cost of bankruptcy is prohibitively high.
B
A firm's cost of equity increases linearly with its debt-to-assets ratio.
C
Replacing equity with lower-cost debt does not alter the overall weighted average cost of capital.
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