A Qualitatively New Effect in Corporate Finance: Abnormal Dependence of Equity Cost of Company on Leverage
Qualitatively new effect in corporative finance has been discovered by the authors: decreasing of equity cost ke with leverage L. This effect, which is absent in perpetuity Modigliani–Miller limit, takes place on account of finite age of the company at tax on profit rate, which exceeds some value T*.
At some ratios between debt cost and equity cost, the discovered effect takes place at tax on profit rate existing in Western countries and Russia. This provides the practical meaning of the discussed effect. Taking it into account is important for the modification of tax law and can change the dividend policy of the company.
In this chapter, the complete and detailed investigation of the discussed effect, discovered within Brusov–Filatova–Orekhova theory, has been done. It has been shown that the absence of the effect at some particular set of parameters is connected to the fact that in these cases, T* exceeds 100% (tax on profit rate is situated in “nonfinancial” region).
- Brusova A (2011) А comparison of the three methods of estimation of weighted average cost of capital and equity cost of company. Financ Anal Prob Sol 34(76):36–42Google Scholar
- Brusov PN, Filatova ТV (2011) From Modigliani–Miller to general theory of capital cost and capital structure of the company. Finance and Credit 435:2–8Google Scholar
- Brusov P, Filatova T, Orehova N, Brusov PP, Brusova N (2011b) From Modigliani–Miller to general theory of capital cost and capital structure of the company. Res J Econ Bus ICT 2:16–21Google Scholar
- Brusov P, Filatova T, Orehova N et al (2011c) Influence of debt financing on the effectiveness of the investment project within the Modigliani–Miller theory. Res J Econ Bus ICT (UK) 2:11–15Google Scholar
- Brusov P, Filatova T, Eskindarov M, Orehova N (2012b) Hidden global causes of the global financial crisis. J Rev Global Econ 1:106–111Google Scholar
- Brusov P, Filatova P, Orekhova N (2013a) Absence of an optimal capital structure in the famous tradeoff theory! J Rev Global Econ 2:94–116Google Scholar
- Brusov P, Filatova T, Orehova N (2013b) A qualitatively new effect in corporative finance: abnormal dependence of equity cost of company on leverage. J Rev Global Econ 2:183–193Google Scholar
- Filatova Т, Orehova N, Brusova А (2008) Weighted average cost of capital in the theory of Modigliani–Miller, modified for a finite life–time company. Bull FU 48:68–77Google Scholar
- Мodigliani F, Мiller M (1958) The cost of capital, corporate finance, and the theory of investment. Am Econ Rev 48:261–297Google Scholar
- Мodigliani F, Мiller M (1963) Corporate income taxes and the cost of capital: a correction. Am Econ Rev 53:147–175Google Scholar
- Modigliani F, Miller M (1966) Some estimates of the cost of capital to the electric utility industry 1954–1957. Am Econ Rev 56:333–391Google Scholar