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Unformatted text preview: d is a constant 8 percent, but r s increases with leverage. Further, the increase in r s is exactly sufficient to keep the WACC constant--the more debt the firm adds to its capital structure, the riskier the equity and thus the higher its cost. Figure 2 plots the firm’s value against leverage (debt). With zero taxes, MM argue that value is unaffected by leverage, and thus the plot is a horizontal line. (Note that we should not really extend the graphs to D/V = 100% or D = $2.5 million, because at this amount of leverage the debtholders become the firm’s owners, and thus a discontinuity exists.)...
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.
- Spring '08