Question

The mm theory with taxes implies that firms should issue maximum debt. In practice, this does not occur because:

Answer 1

Answer:

Explanation:

An optimal capital structure is the objectively best mix of debt, preferred stock, and common stock that maximizes a company’s market value while minimizing its cost of capital.

In theory, debt financing offers the lowest cost of capital due to its tax deductibility. However, too much debt increases the financial risk to shareholders and the return on equity that they require. Thus, companies have to find the optimal point at which the marginal benefit of debt equals the marginal cost.

According to economists Modigliani and Miller, in the absence of taxes, bankruptcy costs, agency costs, and asymmetric informa