7. Summary

The main takeaways of this section are as follows:

  • In our stylized world, the value of the firm is unrelated to its financing policy. Financing decisions do not matter. They simply change the way a given pie (or a bar of chocolate) is split among the providers of capital.
  • The overall cost of capital kA is determined by the operating risk of the company. It is unaffected by financing decisions (changes in leverage).
  • Because kA is free of financing effects, it is often also called the unlevered cost of capital.
  • Changes in the firm’s financing policy affect its cost of the various sources of capital: kD and (especially) kE are positively related to the firm’s leverage.
  • If the firm’s financing policy changes, we therefore have to recalculate its kD and kE, given its kA.
  • Because kA is dictated by the firm’s operating risk, firms with similar operating activities should have similar kA

  

The purpose of this section was to inquire into the relevance of financing decisions. We have seen that, in a perfect world, these decisions do not matter. We also know, however, that financing decisions do matter in the real world. Consequently, the relevance of financing decisions in the real world must be the result of violations of our original assumptions.

The following course section Tax Implications of Debt Financing will drop one of these assumptions: taxes. More specifically, we will study how the considerations from this section change if we switch to a world with taxes. Before moving to this important topic, the next page provides some exercises and real-life applications to practice the key tools from this section.