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The MM proposition II (with no taxes) states that:
AKe increases linearly with debt-to-equity ratio
BKe is independent of leverage
CKe decreases with debt
DKe equals Kd
Answer & Solution
Correct answer: A. Ke increases linearly with debt-to-equity ratio
1. MM Proposition II: Ke = Ku + (Ku − Kd) × (D/E).
2. Cost of equity rises linearly with leverage to compensate for higher financial risk.
3. WACC remains constant.
_Source: ICAI BoS CA Inter Paper 6A, Ch 5 "Financing Decisions — Capital Structure", §2.4_