Corporate Issuers

The market value of a company is independent of its capital structure; firm value is determined by operating cash flows and business risk, not by the debt-to-equity mix.

The cost of equity rises linearly with the debt-to-equity ratio, exactly offsetting the benefit of cheaper debt so that WACC remains constant.

Homogeneous expectations, perfect capital markets (no taxes, no transaction costs, no bankruptcy costs), borrowing and lending at the risk-free rate, no information asymmetry, and investment decisions unaffected by financing.

Because interest is tax-deductible, debt creates an interest tax shield, so firm value rises with leverage: value of levered firm = value of unlevered firm + (tax rate × debt).

The cost of equity still rises with leverage, but WACC declines as debt increases because of the interest tax shield, implying maximum value at nearly 100% debt.

It is the tax saving from deducting interest expense, equal to interest paid × marginal tax rate; it lowers taxes payable, increasing after-tax cash flow available to investors.