The more I think about this reading, the more confused I get. I would think that since required rate of return on equity (Re) increases with levergae (D/E), using M&M from L2, a “safe” firm is the one with a low debt load. However…
Consider a firm with 100% debt = operating assets and no equity. Its beta is zero for equity and operating assets = total assets. Is its WACC really going to be Rf? Because WACC = Rf + beta(op assets) * ERP. Let’s make it even riskier by assuming that now it has a pension plan with assets = operating assets and 100% of its pension plan assets in equity. Total asset beta is still zero, but operating asset beta is now negative (-pension asset beta.) So WACC < Rf?
What kind of wool are they pulling over our eyes here? Maybe M&M were smking something when they asserted that WACC means something and WACC = wdRd(1-t) + weRe.