Leverage Borrowing Rates, Tax Rates And Growth Rates

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Hull, Robert M.
Washburn University. School of Business
Kaw Valley Bank
Issue Date
December 2005
Alternative Title
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.