This chapter is entirely devoted to the explanation of MM's Propositions I and II. Proposition I is proved using a simplified version of MM's "arbitrage" proof. MM's Proposition II is derived using Proposition I. The effect of leverage on the "beta" is discussed. The traditional position on the weighted average cost of capital (WACC) is discussed in detail. Reasons for financial innovation and how violations of MM propositions create opportunities for financial innovations are discussed using real world examples. Lastly, the after-tax weighted-average cost of capital (WACC) is explained using Union Pacific example.
