Capital Structure

[archived_user]

Hey folks, I have a query on the capital structure chapter under the MM1 without taxes and no assumptions relaxed condition(perfect market without any bankrupcy cost, agency cost, taxes and tansaction cost). What I wanted to ask was, How can an investor alter the capital structure according to his preferences by using the borrowed money at risk free rate and using it to finance the share purchases? Example How can he alter a 1:1 ratio of debt and equity to 70% debt and 30% equity by using the borrowed money?

 

[archived_user]

maybe its just me but i dont understand your question… if the money is borrowed surely that will increase D in D/E.. no?

 

[archived_user]

MM1 proposition with no taxes states that the value of the firm does not depend on the capital structure, so it is irrelevant if you finance the company with 90% equity and 10% debt, or 5% equity and 95% debt. This is really unrealistic.
Then appears MM2 proposition with no taxes, which also states that the value of the firm is unaltered by the capital structure, but explains that it is because the WACC does not change. The higher the debt, the higher the equity return shareholders will demand on the stock maintaining the initial WACC invariant.
If I’m correct, you are talking about issuing debt at the risk-free rate to buyback shares? At the company level, debt is issued for many intentions, but any buyback of shares will change the capital structure.

 

[archived_user]

Oh yeah, I would’ve guessed that too earlier, but there had been a slight ambiguity coz they had mentioned that he finances his share purchases with leverage, instead of share repurchases made by him through leverage. Thanks.