Session 18: Optimum Capital Structure - The Cost of Capital Approach

In this session, I start by using the trade off on debt to lay out the basis for the Miller Modigliani proposition that financial leverage does not matter. I then discuss why firms prefer retained earnings to new debt issue to new equity issues, in that order. The rest of the session was spent developing the cost of capital approach to optimize debt ratios.

[ramjiYahoo]

Great Video Professor sir, great as always

[ashutoshgoenka]

Thank you Professor for sharing the video on this topic with such an elaborate explanation.

As mentioned in the video, when we go for the optimal capital structure, the extra value is due to the tax benefit that debt has. However, If we take the tax rate as 0, there is a possibility that the new WACC can still be lower than the existing WACC and this can again lead to an increase in overall valuation. Is this value increase due to the fact that now as the cost of capital has gone down but we are still making the same level of cash flows?

[VicAM]

This is a great video but there is an issue with the 50% level: All calculations can be recreated if the pre-tax cost of debt for Iteration 2 is used as the starting point for pre-tax cost of debt for the next level’s Iteration 1. The only issue is at 50%. This pre-tax cost of debt for Iteration 1 jumps to 10% vice the pre-tax cost of debt for 40%’s Iteration 2 (3.75%). See 41:00

[MyDreamside]

is there somewhere that explain why use book value of dept and not market value of dept when calculating Enterprise value. If someone can buy dept in discount then he can erase book value of dept. But on the other hand you cant buy the entire dept since not all is sellable on the market, same goes with equity not all equity holders are selling at current prices. So the Enterprise value is not accurate in large buy positions since large buy positions can change the the market prices

[samuelmundia]

Thanks alot professor.. But the slides in this lecture are for lecture 17, so kindly re-upload the slides for lecture 18 to match the discussion..
Thanks alot for sharing your knowledge.. Am from kenya..

[rupamkatte]

Professor, why are we calculating Debt in terms of total capital(137, 839), shouldn't we calculate debt in proportion of EQ only?, coz total capital is going to change as debt change.

[bemonbemon-tn]

Thank you professor, ur video helped me so much :)🥰🤑

[ntcuongct]

Dear Friends, I think each capital budgeting have own capital structure. Now, with 10 capital budgeting, I want to make the summary report of Capital structure. Could you share?. Thank you.

[JonesDawg]

Thanks professor, for the assignment at the end:
# of shares after buyback = 1800 - 39, 175/85 = 1339.12
Value per share after buyback = 102, 326/1339.12 = 76.41
So all the current equity holders would like to sell back their shares to the firm.