In Figure 8.11 we saw the traditional view of the relationships between the cost of capital and
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In Figure 8.11 we saw the traditional view of the relationships between the cost of capital and the level of borrowing and the relationship between the value of the business and the level of borrowing. How would the MM view of these two relationships be shown in graphical form?
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Cost of capital Cost of ordinary share capital --.-..------.................Overall cost of capital Cost of loan capital Level of borrowing The MM view assumes that the cost of capital will remain constant at different levels of gearing. This is because the benefits of cheap loan capital will be exactly offset by the increased returns required by ordinary shareholders. Thus, there is no optimal level of gearing.
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