Dear Sir,
The value of the firm can achieve at max point, ie at lowest WACC.
But when it explained another way, ie The value of the firm will reach a max point where the marginal benefits of tax relief equal the marginal cost of financial distress, I can not get the point. Where am I lost? What logic is in this theory?
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Static Trade-off Theory
11y ago#1Your first line is M&M.
What the second paragraph means is the the reason for the WACC reducing is because of the benefit of tax relief on more debt being used to finance the business. However, as more debt is raised then the risk to equity increases and there will come a time when the higher cost of equity is great that the benefit of the tax relief on the debt - when that happens the WACC would start to increase and therefore a minimum has been reached.
However, you would not be expected to write that in the exam (but it is explained in the free lecture on M&M)
Thank you very much!
11y ago#3You are welcome :-)
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