The correct answer is: C. MM Model with Taxes.
The MM Model with Taxes argues that the value of a levered firm is higher than that of an unlevered firm because of the tax deductibility of interest expense. This means that a levered firm can use debt financing to reduce its tax liability, which increases its after-tax cash flow and, therefore, its value.
The Net Income Approach and the Net Operating Income Approach both argue that the value of a firm is equal to the present value of its future net income or net operating income, respectively. These approaches do not take into account the tax deductibility of interest expense, and therefore they do not predict that the value of a levered firm will be higher than that of an unlevered firm.
Here is a more detailed explanation of each option:
- Net Income Approach: This approach argues that the value of a firm is equal to the present value of its future net income. Net income is calculated as revenue minus expenses, including interest expense. This approach does not take into account the tax deductibility of interest expense, and therefore it does not predict that the value of a levered firm will be higher than that of an unlevered firm.
- Net Operating Income Approach: This approach argues that the value of a firm is equal to the present value of its future net operating income. Net operating income is calculated as revenue minus operating expenses, excluding interest expense. This approach also does not take into account the tax deductibility of interest expense, and therefore it does not predict that the value of a levered firm will be higher than that of an unlevered firm.
- MM Model with Taxes: This approach argues that the value of a levered firm is equal to the value of an unlevered firm plus the present value of the tax shield on debt. The tax shield on debt is the tax savings that a firm receives from deducting interest expense from its taxable income. This approach predicts that the value of a levered firm will be higher than that of an unlevered firm because of the tax deductibility of interest expense.