Modern capital structure theory constructed by Modigliani and Miler, began in 1958 and provided justifications for increasing leverage under certain assumptions. CEDs and CFDs were encouraged to adopt this theory into practice, especially when spending is high and the risk of servicing debt is low. As capital markets have evolved, it is critical in understand the context and assumptions under which this model was created. Review the situation and answer the questions that follow: An analyst has graphed the relationship between the expected return on a firm's capital and its debt-equity (DYE) ratio. Here graph follows: From what you see on the graph, which of the following assumptions is consistent with the graph? The firm's debt has no default risk. If leverage increases, the cost of equity increases enough to keep the weighted average of capital (WACC) constant. Excessive financial leverage causes a decrease in the firm's EBIT (earnings before interest and taxes). Excessive financial leverage causes equity to become less risky than debt. Based on the assumption that a firm operates in a tax-free world, Modigliani and Miler made an important proposition about the value of a levered portfolio (V_L) and an undelivered portfolio (V_u). Which of the following equations best represents the conclusion from the WW: We Tax theory? nu_u notequalto nu_L nu_u = S_L - D nu_L = S_L = D nu_L = S_L + D_L