The correct answer is: D. MM approach
The MM approach, or Modigliani-Miller approach, is a theory of capital structure that states that the value of a firm is not affected by its capital structure. This means that the overall capitalization rate and the cost of debt remain constant for all degrees of leverage.
The MM approach is based on the following assumptions:
- There are no taxes.
- There are no transaction costs.
- There are no agency costs.
- Investors are rational and have homogeneous expectations.
- The market is perfect and there is no asymmetric information.
Under these assumptions, the MM approach shows that the value of a firm is equal to the present value of its expected future cash flows, regardless of its capital structure. This is because the cost of debt is equal to the cost of equity, and the tax shield on debt is irrelevant.
However, the MM approach has been criticized for its unrealistic assumptions. In reality, there are taxes, transaction costs, agency costs, and asymmetric information. These factors can affect the value of a firm and make the capital structure important.
Despite its limitations, the MM approach is a useful tool for understanding the relationship between capital structure and firm value. It provides a starting point for analyzing the impact of capital structure on firm value.
The other options are incorrect because they do not support the statement that the overall capitalization rate and the cost of debt remain constant for all degrees of leverage.
- The traditional approach to capital structure is based on the idea that the value of a firm is affected by its capital structure. This approach argues that the optimal capital structure is the one that minimizes the firm’s cost of capital.
- The net operating income approach to capital structure is based on the idea that the value of a firm is equal to the present value of its net operating income. This approach argues that the optimal capital structure is the one that maximizes the firm’s net operating income.
- The net income approach to capital structure is based on the idea that the value of a firm is equal to the present value of its net income. This approach argues that the optimal capital structure is the one that maximizes the firm’s net income.