( WACC ) Miller & Modigliani

Traditional view:
they say that as the loan capital increases in total capital structure of company, as debt is cheaper, the wacc (average rate from the combination of rates of debts and equity) will come down. which is understandable because debt is cheap so rate would be cheap. but shareholders r clever after certain level of debt, they would want to increase their return as company might face liquidation due to high gearing.

M and M no tax: according to this theory they say that change as debt financing increases, shareholders will react to it quickly and wil increase their return demand. so on the one hand debt fianncing making wacc low, on the other hand returns for equity demand r rising. so wacc remains unchanged.

M and M with tax: in real life there r tax implications. so they revised their theory. this goes like debt is net of tax. i.e. tax deductible. so the interest u pay on tax will help u to pay less tax. now what happens is, debt will look even more cheaper because of its tax benefit.. so basically the more debt in ur capital structure investors i.e. the equity holders will increase their demand for return as the debt level increases but the proportion of increase of gearing. but tht INCREMENT wont be as much as the benefit from debt being tax decutible. so in theory its better if co is 99% debt financed.

but we know that can lead to liquidity hence not advisable.
HOPE IT MAKES SENSE 🙂