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October 17, 2015 at 2:35 pm
Graph 3.1 shows the cost of debt alone to be lower than the the cost of equity and WACC.suppose we r fully debt financed wouldnt the overall cost be the maximum of cost of debt which is lower than the constant WACC(as per graph).
So is the graph correct in that regard?
John Moffat says
October 17, 2015 at 3:46 pm
As I explain in the lecture, at very high levels debt takes on the risk of the business and can no longer be regarded as risk free.
October 18, 2015 at 5:41 am
Am sorry I didnt quite get u .so is the graph ryt or wrong?
Let me make my ques once more clear to u
Even at high levels if the cost of debt didnt rise till the wacc level(as per the graph) then hw will MnM model of constant WACC be establishd?
October 18, 2015 at 6:46 am
In theory the cost is debt would rise to the WACC because of what I wrote before. If they were all debt financed the debt would take on all the risk of the business and therefore require the same return as equity would if it were all equity financed.
However this is all hypothetical because it is not possible to be all debt financed (and it is assuming no tax).
The graph is only meant to be illustrative.
October 18, 2015 at 7:18 am
I had already understood wht u said there.it was tht the rise of cost of debt in the graph which didnt meet the wacc level which made things a bit confusing.So I can well assume tht the grph is not 100 percnt correct?
Thanks for the quick reply:-)
October 18, 2015 at 8:08 am
The graph is not meant to be 100% correct – that would never be possible and is completely irrelevant. You cannot possibly draw a correct graph in real life, and you are never required to draw a graph in the exam (although it is one way of explaining the idea, which for some people is easier than writing it in words).
What matters is that under the traditional theory, the WACC stands to change and that therefore there has to be a minimum. That is all!!
Calculations and graphs are never required. This is purely an illustrative graph – illustrative graphs do not attempt to be accurate.
October 18, 2015 at 8:48 am
I didnt know abt illustrative graphs n their accuracy.thts new to me.
Thanks tht ws so helpful
Keep up the good work
April 15, 2015 at 1:29 pm
Sir i have a question that If the company is entirely finance by 100% of Equity and 0% of Debt(as u mentioned in the question) then where did the cost of Debt come from (i.e 10% give in the question above)
April 15, 2015 at 3:38 pm
Firstly the example was only an illustration (and as I explained in the lecture, you could not be expected to do any numbers in the exam, just to be able to write what M&M said).
Secondly, however, it is still possible to obtain a cost of debt borrowing even if you don’t borrow any! (I do not borrow money from the bank, but I know what interest I would be charged if I did borrow )
April 19, 2015 at 3:54 pm
April 1, 2015 at 3:02 pm
May i know for chapter 19 answers to examples 3 have a sentence ‘ New : Eg + Dg = 35 + 10 x 0.3 = 38M ‘ , what that means ?
March 19, 2015 at 7:04 pm
Mr Miller was a very clever man. He came up with this theory which we are all studying. Then he set up a trust (or whatever its called) where people put in alot of money so he could invest it on their behalf. And it collapsed. makes me wonder why am i even studying when this doesnt sort of make sense in the real world out there. Just saying as i see it. I guess u learn the real deal through experience rather than theory. Guess thats just the way it is. No wonder Albert Einstein hated a prescribed way of learning. Now its just more evident why the richest are school dropouts. Great lectures on f9 on the brighter note. thankyou
August 2, 2015 at 1:54 pm
Good observation. Why are ACCA making us learn a theory which failed miserably in real life!!!!
August 2, 2015 at 4:57 pm
The collapse of his mutual fund was nothing to do with his theories. The theories that he and Modigliani came up with formed the basis of all financial management theory and have had profound affects. The requirement to produce Statements of cash flows is just one indirect result of their work.
They didn’t receive a Nobel prize for nothing
March 14, 2015 at 6:25 am
I was watching this as part of my revision for P4, as it has come up in a past P4 question which I’m practicing and I had no clue of capital structures because I did F9 a long time ago but now I’ve refreshed my memory. Thanks.
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