Effects of a corporate tax on the WACC
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Can one minimizeWACC when there is a constraint on raising debt and how?
What are the effects of a corporate tax on the WACC of a business?
Is minimizing WACC by having a largely debt-based capital structure a high-risk strategy, given the threat of bankruptcy in an overleveraged business?
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This discusses the effects of a corporate tax on the WACC
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Can one minimizeWACC when there is a constraint on raising debt and how?
A firm's optimal capital structure is that mixture of debt and equity than minimizes its weighted average cost of capital (WACC). Since the after-tax cost of debt is lower than equity for many corporations, why not use debt only or mostly? It turns out that, while debt reduces a company's tax liability because interest payments are deductible expenses, increasing amounts of debt raise both the cost of equity capital and the interest rate on debt because of the increasing probability of bankruptcy. In other words, higher amounts of debt raise the financial risk of a company, and this risk is reflected on the cost of all the types of capital the company uses. As such, the relationship between financial leverage and WACC is not a straight line, but more of a ...
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