Leverage Borrowing Rates, Tax Rates And Growth Rates

Abstract

This paper extensively broadens the perpetuity gain to leverage (GL) equations of Modigliani and Miller (1963) and Miller (1977) by developing a capital structure model (CSM) that contains a series of perpetuity GL equations applicable to a variety of situations. The CSM equations show how changes in tax rates, growth-adjusted equity discount rates and debt discount rates influence firm value. These three "change-rate" factors are missing from the MM-Miller framework explaining why their equations cannot account for leverage-related costs leading to an optimal debt level. Also, the CSM extends MM-Miller by addressing a leveraged situation where wealth transfers can result. Finally, the outcomes of the CSM equations support the predictions of major capital structure theories and clarify points of controversy.