Hi, for Q (1) (c) sample answer, under the Calculation of Gearing, please may I know what does the sentence "Higher levels of debt may result in the cost of equity rising, reducing the overall impact on the cost of capital" mean?
Thank you.
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ACCA (AFM) past year (6 March 2020)
4y ago#1It is stating Modigliani and Millers' proposition with taxes. This is revised briefly in Chapter 12 of our free lecture notes (and the lecture working through the chapter) and is explained in detail in our free Paper FM lectures.
Oh.. does this mean that with higher levels of debt, according to the Modigliani and Miller Proposition (with taxes), will "increase" the cost of equity. Since the higher level of debt could "reduce" the overall cost of capital due to tax relief, the "increase" thereof reduces the overall impact on the cost of capital after balancing the upward/downward movement?
Please may I know whether my interpretation is correct? Thank you. :)
4y ago#3That is correct (although I do think you should also watch the lectures).
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