first of all i want to thank you so much for your lecture about traditional theory and M&M about capital structure. you delivered this lecture in such a simple way, yet include all the important points, which should be there to make the students to comprehend the theories.

in the video you mentioned that M&M theory assumes that the debt is irredeemable. and this has caused the Kd to be in the consistent rate. is my interpretation about the assumption correct ?

The proof of M&M (which is not required for the exam) does assume that the debit is irredeemable. However the fact that Kd is constant is because we assume also that the debt is risk-free. The assumption that it is irredeemable is because otherwise the gearing would change in the future due to having to repay it.

Why not? Maybe you could borrow money from the bank at a cost of 10% â€“ it doesnâ€™t mean you will necessarily be borrowing it ðŸ™‚

Anyway, the graph is only of relevance in explaining what happens to the WACC and since they are not borrowing debt at 0% gearing, it is not included in the calculation of the WACC!!

tanyanti says

Hi John,

first of all i want to thank you so much for your lecture about traditional theory and M&M about capital structure. you delivered this lecture in such a simple way, yet include all the important points, which should be there to make the students to comprehend the theories.

in the video you mentioned that M&M theory assumes that the debt is irredeemable. and this has caused the Kd to be in the consistent rate. is my interpretation about the assumption correct ?

thanks in advance for your response

John Moffat says

Thank you for your comment ðŸ™‚

The proof of M&M (which is not required for the exam) does assume that the debit is irredeemable. However the fact that Kd is constant is because we assume also that the debt is risk-free. The assumption that it is irredeemable is because otherwise the gearing would change in the future due to having to repay it.

tanyanti says

Thanks ðŸ™‚ once again, what a mind-blowing explanation.!

John Moffat says

Pecking order theory is concerned with the raising of long-term capital (not short-term finance, which is what delaying payments is).

ekuri says

Hello sir. Please can tax benefits be applied to preference shares?

apoorvakudva says

No. Because preference share holders get dividend and dividends are not tax allowable.

alastairk says

Hi John,

In terms of financing working capital , within the pecking order theory where would you place

withholding supplier payments?

alinaqvi111 says

Hello sir,

How can there be a cost of debt 10% in the example 1 when there is no debt at all. 0 % share of debt is given in scenario 1 of example 1?

John Moffat says

Why not? Maybe you could borrow money from the bank at a cost of 10% â€“ it doesnâ€™t mean you will necessarily be borrowing it ðŸ™‚

Anyway, the graph is only of relevance in explaining what happens to the WACC and since they are not borrowing debt at 0% gearing, it is not included in the calculation of the WACC!!

alinaqvi111 says

That expalains it.

Thank you ðŸ™‚

John Moffat says

You are welcome ðŸ™‚