capital-structure irrelevance-its does not matter what capital structure a company uses to finance its operations the value of the company does not change
The higher the cheaper debt, the higher the cost of equity, which will be offset each other
But how about the higher the equity finance? as the higher the equity finance should lower the gearing level, which should lower the cost of equity? why not raise more equity finance compare to debt finance?is it because it will increase the issue costs?
Have watched the video lecture but still have this question in mind,hope tutor can explain it to me,thank you so much.
Ask the Tutor ACCA FM
M&M theory
7y ago#1Firstly, your first sentence is correct but only if there is no tax (and that the assumptions made by M&M were all to be true).
Issue costs are irrelevant to the theory - M&M assume no issue costs.
More equity means lower cost of equity. But since there is more equity (which will still cost more than the cost of debt) then the two effects 'cancel out'.
Look again at example 2 in the chapter - even if they are 100% equity financed, then the WACC is still the same as it is when there is gearing.
Sign in to reply to this topic.