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- This topic has 2 replies, 2 voices, and was last updated 4 years ago by John Moffat.

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- June 10, 2020 at 9:36 am #573351
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.

June 10, 2020 at 9:46 am #573355Sorry, 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)June 10, 2020 at 10:11 am #573361No, 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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