Consider the three capital structure theories: MM (Modigliani-Miller) without taxes, MM with corporate taxes, and the trade-o theory.

(a) Draw a graph with rm value on the vertical axis and financial leverage on the horizontal axis, and on the graph illustrate the value of a rm under each of the above three theories of capital structure. When applicable, indicate the present value of tax advantage, value of bankruptcy cost, and the net gain from leverage.

(b) What is the optimal capital structure for each of the three theories?