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sir, could you pls. explain me what is meant by “interest is tax-deductible”? I know that tax is deducted after deducting interest. But what should I understand when it is said like WACC falls because the interest is tax- deductible in traditional theory?? I am not getting the logic still. And why does WACC increase after optimal point of gearing? Why is minimised WACC better? Is it because that will give a positive NPV which is always good??
Please help. I am so confused.
Paying interest means that there is less tax payable – that makes the net cost of debt borrowing lower than it otherwise would be (and therefore attractive)
All that traditional theory says is that the WACC stands to change with different levels of gearing (not that it always falls). If it is going to change then there must be a level of gearing at which the WACC is a minimum.
WACC is the overall cost of borrowing for a company – they would always want to borrow in the cheapest way.
(Minimum WACC certainly does not guarantee a positive NPV!!)
I do suggest that you watch the free lecture on the theories of gearing, where all of the above is explained in full.
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