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John Moffat.
John Moffat.-
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Faizahmad1009
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Sir you were explaining in the lecture that if a company is deciding to raise $500,000.
It should consider various factors such as raising all the money from the debt since it is cheaper and tax-allowable would cause rise the cost of equity because more gearing creates more risk to shareholders.
On the other hand, we cannot simply raise the money from equity because then company has to bear higher cost of equity. Further, the cost of equity consists of riskiness of business which is evaluated by Asset Beta and the riskiness of investment (i.e. shares) which is evaluation by Equity Beta.
So what is the best way to raise the finance? Is it correct Equity/Debt ratio of 60%/40% is the best solution for this suggested by Traditional Theory?
John Moffat
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I have no idea whatsoever where you are getting a 60%/40% ratio from – traditional theory does not suggest any specific ratio!
If there is tax, then in theory the company should always raise as much debt as possible as per Modigliani and Miller.
In exam questions it depends on whether you are being asked to write about this in general terms, or whether it is relating to a specific situation in which case it will depend on the circumstances given in the question.
Faizahmad1009
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