MM (Proposition I) showed that the firm’s value is not affected by its choice of capital structure in a perfect capital market.

Assume you use no leverage and create an all-equity firm. An investor who would prefer to hold levered equity can do so by using leverage in his own portfolio using “homemade leverage.”

(1) Assuming the initial cost of unlevered equity is $1,000, the initial cost of levered equity is $500, and the risk-free interest rate is 5%, prove MM Proposition I using homemade leverage. (10%)

(2) Explain why homemade leverage can be considered to be their insight to establish MM Proposition I. (5%) Get Finance homework help today