Sign in
Mr. Harris would likely recommend a debt level that is low enough to minimize the present value of financial distress costs, while Ms. Broske would recommend a debt level that minimizes the firm’s weighted average cost of capital. The data suggests that Ms. Broske would recommend $6 million in debt, because this is the lowest weighted average capital cost. It isn’t clear what level of debt Mr. Harris would suggest, however, it appears that it would be less than $6 million to reduce the current value of financial distress.
They both seek to establish the ideal capital structure of the firm. But the way to determine that optimal structure is different. Mr. Harris uses the MM framework which focuses on minimizing the present value of financial distress costs, while Ms. Broske uses the WACC approach which focuses on minimizing the firm’s weighted average cost of capital. Both have advantages and disadvantages. It all depends on what information is available and your specific circumstances. There is no one right approach. The choice of which method to use depends on your goals and what data are available.
