The correct answer is: D. All of the above
The Modigliani-Miller (MM) irrelevance proposition states that in a perfect market, the capital structure of a firm does not affect its value. This is because investors can create their own homemade leverage by borrowing money on their own to purchase shares in the firm. This arbitrage process will drive the cost of equity up or down until the value of the firm is unaffected by its capital structure.
The cost of debt is the interest rate that a firm pays on its outstanding debt. The cost of equity is the rate of return that investors expect to earn on their investment in the firm. The weighted average cost of capital (WACC) is a measure of the overall cost of capital for a firm, and it is calculated by taking a weighted average of the cost of debt and the cost of equity.
The MM irrelevance proposition is based on the following assumptions:
- There are no taxes.
- There are no transaction costs.
- There are no information asymmetries.
- Investors are rational and have homogeneous expectations.
- The firm is a going concern.
If any of these assumptions are violated, then the MM irrelevance proposition may not hold. For example, if there are taxes, then the cost of debt will be lower than the cost of equity, and the firm will benefit from using debt financing.
The MM irrelevance proposition has important implications for corporate finance. It suggests that firms should not worry about their capital structure, and they should focus on maximizing their operating profits. However, the MM irrelevance proposition is based on a number of unrealistic assumptions, and it may not hold in the real world.