M&M Proposition II is the proposition that:

A) Supports the argument that the capital structure of a firm is irrelevant to the value of the firm.
B) The cost of equity depends on the return on debt, the debt-equity ratio and the tax rate.
C) A firm's cost of equity capital is a positive linear function of the firm's capital structure.
D) The cost of equity is equivalent to the required return on the total assets of a firm.
E) Supports the argument that the size of the pie does not depend on how the pie is sliced.

Question

Rohit Dhende · Accepted Answer

Final Answer : C, Explanation :  M&M Proposition II states that a firm's cost of equity capital is a positive linear function of its capital structure, meaning as a firm increases its leverage, its cost of equity also increases. This reflects the increased risk to equity holders as debt levels rise.

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