1. The trade-off theory states that capital structure decisions involve a trade-off between the costs and benefits of debt financing.

a. True

b. False

2. Modigliani and Miller’s first article led to the conclusion that capital structure is “irrelevant” because it has no effect on a firm’s value.

a. True

b. False

3. In a world with no taxes, Modigliani and Miller (MM) show that a firm’s capital structure does not affect its value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., the firm’s value rises as its uses more and more debt, other things constant.

a. True

b. False