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Sir i know that as gearing increases, the proportionate share for equity will increase also but overall, the WACC will fall because of the trade off effect of taxation associated with debt.
However, can you advise me sir as to whether if there exists a point in time when if debt (gearing) increases beyond a certain level the WACC will start to rise and can you outline some instances that would contribute to such a rise in WACC?
Or
Would the WACC continue to decrease indefinitely as long as debt (gearing) increases.
Thank you.
As I explain in my free lectures, M&M assume that at normal levels of gearing the debt is risk free and therefore the cost of debt remains constant and the WACC falls with higher gearing.
However at very high levels of gearing the debt become more risky (because the ability of the company to pay the fixed interest is more risky) and the cost of debt will rise and this would start to increase the WACC.
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