Hi
Im getting confused with the M&M theory. When u increase debt it increases the gearing and so the risk to shareholders increases and therefore so does the cost of equity, which is shown in the graph as the equity line increases with gearing. However, why is the cost of debt always a straight line and then it eventually increases at higher levels of gearing? An increase in debt increases gearing right? So then why is the line constant and then it increases later? I think I missed something important or didnt get the concept. Sorry if this is a dumb question but at the moment i feel like im just confused and missing/forgot something critical so I thought it'd be better to clear it up. Can someone please explain the reasoning behind this?
Thank you