Why according to MM2 investors indifferent to leverage?
No tax / no bankruptcy case.
MM2 states that return on equity is proportional to leverage (D/E).
Question then is - why are shareholders indifferent to leverage? Why does it not create shareholder value (again this is no tax, no bankruptcy case)?
In the book I am supposed to study corp fin from the explanation is shit so would appreciate help.
Thanks!
If I remember MM2 correctly, leverage increases return on equity but also increases risk, such that the overall reward vs. risk stays intact. I think this should be generally google-able.
As you take on more debt, the equity position becomes riskier. The idea of MM is that, in a world where leverage is only about splitting the pie in a different way (no tax world), leverage increases the expected return on equity and increases the risk of equity proportionally, such that the risk-adjusted value of the equity doesn't change.
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