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Sir I am confused in 1 area that
Increase in gearing increase financial risk for shareholders causing increase in shareholders required return (i.e cost of equity) leading to increase in WACC. When we say this statement, do we assume traditional theory?
Increase in gearing leads to decrease in WACC. When we say this statement, do we assume M&M with tax theory?
Generally which theory we should assume for examination purpose and generally which theory is better?
Increase in gearing only increases the WACC in traditional theory if the company is already at its optimal level of gearing.
With MM (with tax) higher gearing results in lower WACC.
You don’t assume either theory – it depends on the question.
All of this is explained in my lectures – please don’t expect me to type out all my lectures here.
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