FROM NOTES BOOK 2 #SS5, PART C, IT SAYS THAT MANAGEMENT CAN ATTAIN OPTIMAL WACC BY ADJUSTING ASSET BETA, WHICH DECREASES WHEN DEBT/EQUITY INCREASES, OR INCREASES WHEN THE REVERSE HAPPENS. WHY?
In the shower after a long day
bcoz asset beta is wt avg of beta of debt + equity. beta of debt is typically assumed to be zero… so as the debt/eq ratio increases, the asset beta drops. - BN
you should not read this text as normal way as we used to do. do not think of risk coming from high debt, normally we think higher debt - leads us to higher risk and wacc goes up but here not that way, remember debt has tax consecuences ? so when you incorporate more debt, your wacc goes down because cost of equity „@cost of debt remember the (1-tax) ? if you put (1-tax) obviously your debt cost becomes lower. wacc goes down