Hi everyone,
what is the effect of leverage on stock prices, should you expect better performance from a company with high leverage that is not going to suffer from cyclicality/downturn?
My understanding is that higher leverage boosts ROE so you should expect better performance from that part.
Also, I would like to understand how this relates to the WACC theory point of view. Technically as long as you are in the U-Shaped optimum of your cost of debt/equity (not where your cost of equity goes down due to increase in bankruptcy risk) how much debt you have should not matter for your cost of equity and thus your stock price.
Would be good if you guys could shed some light on those 2 points, specially on the relationship between cost of equity (and how debt would influence this) and share price.
Debt always increases the cost of equity, the U-shape is for the total cost of capital. Sure, debt is cheaper than equity but at any level, leverage makes a company riskier. The more levered you are, the higher your beta.
So the market cap of the company should decrease with increase debt? Since we are discounting all the levered cash flows with a higher discount rate.
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