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1. Does all theories assume that the amount of finance do no change, it’s just that debt/equity replaces each other ?
2. With MM theory don’t they ignore risk of default so why does the graph show that at very high gearing, cost of debt increases?
3. Why does the fisher effect say that real interest rate is the same in every country. Because doesn’t inflation make the “real” value of money lower and all countries have different rates of inflation?
1. The theories of gearing do not assume that the total amount of finance does not change.
2. M&M ignore the risk of default at ‘normal’ levels of gearing, but accept that at very high levels then the risk of default cannot be ignored. (And before you ask, there is no definition as to what is a ‘very high’ level of gearing and it is not particularly relevant because the company would not find people to borrow from if the level of gearing were that high.)
3. In theory, the only reason why the actual rates of interest change is because of changes in the rate of inflation.This applies within an individual country, and in a perfect world would also apply between different countries.
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1. In the technical article and in Grenarp Co BPP they both refer to “gearing up” as replacing equity with debt though?
3. So is it right for me to think that real means every country from starts from T0 on an equal footing, but due to inflation their nominal differs—and this also applies to cash flows?
1. So? The theories do not assume that the total finance remains the same – just that the level of gearing changes. (Obviously in Grenarp the total finance is changing.)
2. I think you are confusing investment appraisal with inflation with forecasting future exchange rates. They are two separate things.
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Alright. Thank you so much Sir!
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