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Hello Mr Moffat
Thank you very much for your lectures. Really appreciated.Sorry, I am a little confused about M&M yet. So far I though there are two propositions:
1 – M&M proposition without tax
2- M&M proposition without tax
But I feel i am wrong! I mean it seems there are FOUR propositions! Is it correct to say in fact there are 2 main theories, and each has 2 proposition. I mean:1 – M&M first theory (without tax)
1-1: Proposition 1: Cheaper debt is exactly offset by increase in cost of equity.
1-2: Proposition 2: WACC = Ve*Ke/(Ve+Vd) + Vd*Kd/(Ve+Vd)1 – M&M second theory (with tax)
2-1: Proposition 1: The company should borrow as much as possible ( because of tax shield)
2-2: Proposition 2: WACC = Ve*Ke/(Ve+Vd) + Vd*Kd*(1-t)/(Ve+Vd)I just want to make sure that this classification is fine …
Thank you very much.
Sorry, there were some typing mistakes in the above post. So I just amend it:
So far I though there are two propositions:
1– M&M proposition without tax
2- M&M proposition with tax
But I feel i am wrong! I mean it seems there are FOUR propositions! Is it correct to say in fact there are 2 main theories, and each has 2 proposition. I mean:1 – M&M first theory (without tax)
1-1: Proposition 1: Cheaper debt is exactly offset by increase in cost of equity.
1-2: Proposition 2: WACC = Ve*Ke/(Ve+Vd) + Vd*Kd/(Ve+Vd)2 – M&M second theory (with tax)
2-1: Proposition 1: The company should borrow as much as possible ( because of tax shield)
2-2: Proposition 2: WACC = Ve*Ke/(Ve+Vd) + Vd*Kd*(1-t)/(Ve+Vd)No, there are not 4 propositions.
1-2 and 2-2 are not M&M. There is no need for 1-2 because if t is zero then automatically you get 1-2 using 2-2 !!! (And as I explain in my lectures, this formula is rarely used because debt is more likely to be redeemable in which case the cost of debt is not kd(1-t)).
M&M explain how (in theory) the cost of equity changes with higher gearing, which is why statements 1-1 and 2-1 are correct.
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