MM Proposition II shows that the cost of equity rises with leverage.
- According to the second tenet of the M&M Theorem, a company's cost of equity and level of leverage are directly inversely related. Increased leverage increases a company's likelihood of defaulting.
- According to Proposition I, a company's market value is unaffected by the ratio of debt to equity in its capital structure. According to Proposition II, the cost of equity is directly and inversely proportional to the amount of debt in the capital structure.
- The capital structure irrelevancy theory is supported by the Modigliani and Miller approach to capital theory, which was developed in the 1950s. This shows that a company's capital structure is unaffected by a firm's valuation.
Thus this is the answer.
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