We say that if cost of debt and cost of equity increases then WACC too increases but another statement is that WACC falls with higher gearing, so high gearing ultimately means high cost of debt and here due to high cost of debt WACC will increase so isn't this statement contradicting with the first statement which says that if cost of debt and cost of equity increases then WACC also increases?
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cost of debt and cost of equity
7y ago#1You must watch my lectures on this - I explain it in full with graphs.
The cost of debt will always be lower than the cost of equity and therefore more gearing means more (cheap) cost of debt and therefore lower WACC.
Higher gearing results in lower WACC, but this will hold true ONLY in M&M with tax theory?
Secondly if any mcq comes in exam related to capital structure theories, and if its not mentioned that use traditional theory or M&M with tax or M&M without tax theory then which theory shall we assume?
7y ago#3Yes - that is exactly what I say in my lectures. With tax the WACC will fall with higher gearing. Without tax the WACC will stay constant.
The question will have to make it clear by way of the information given in the question.
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