Module II· WACC & Capital StructureAdvanced
Question
What is the Modigliani-Miller insight, and why does it matter for WACC discussions?
Answer
MM theorem (without taxes)
Firm value is independent of the capital structure. If you increase leverage, CoE rises by exactly enough to keep WACC constant. MM (with taxes): value rises with leverage because of the tax shield — until distress costs kick in. Consequence for IB practice: reducing WACC through more leverage is NOT a real value gain — you trade equity risk for a lower cost of capital. Real value comes only from the tax shield (and the discipline of debt service).
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Pitch tip
If a senior asks 'can you create value through more leverage?' — the right answer is 'only via the tax shield, not from the WACC-reduction effect itself — that is an illusion in the MM world.'