Starting with WACC for pure equity company:
= (D/D+E) Rd + (E/E+D) Re
Where Ra is average return from assets, Rd and Rd are return on debt and equity respectively.
MM I states Ra is invariant to financing, thus Re adjusts by just enough to keep WACC constant when debt levels change
WACC w corporate taxes
= (D/D+E) Rd (1-tc) + (E/E+D) Re (2)
only difference now is the addition of (1-tc) as a multiplier to transform Rd into effective Rd
My question is that when I rearrange (2) to find Re I get:
Re = Ra + D/E [ Ra- (1-Tc) Rd )
which is clearly different from MM II’s formula:
Re = Ra + D/E ( Ra - Rd ) (1-Tc)
am I doing anything wrong? The formulas don’t tally.