is the tax shield to blame for the problems with credit

[morganist]

Quote from sjfan:

First, I think you are mixing up the concepts of WACC and CAPM. CAPM is used to derive an input into WACC: the equity input. Debt cost is a parallel input that does not assume CAPM. So, while I see you have a problem with debt cost in relations to WACC, I don't see what problem you have with CAPM. CAPM does not take debt into account.

Second, I find it a little silly that your entire argument on why WACC matters (which it does, but not in the way you think) is because business schools devote a lot of time to it. I assure you, as someone who has gone to a top tier business school and employed in a segment of the investment business that make use of such concepts, that the basic WACC is rarely used beyond a simple reporting number.

Third, while I see your point that a low debt cost implies a low total cost of financing and therefore create for capex, I don't see why "tax shield" is "to be blamed". The leverage effect of the tax shield is tiny compared to all the other factors.

So, if you want to argue that in the last few years debt has been too cheap, that's true. I don't think corporate debt is what got us in trouble, but sure - at least you are making a reasonable suggestion. But the tax shield as the blame is unreasonable to the extreme.

yeah sorry i got the capm and the wacc in the wrong order. the reason that i raised it as a point is that a political party in my country is adopting a debt management mechanism in a bid to control the level of debt in companies. my point being if that happens the tax shield would create problems as there is an incentive to increase debt over equity in many cases.

also the wacc (not the capm, my error) can be used to calculate investment decisions. thus if a credit crunch occurs if there is a higher level of debt due to the tax shield it could affect equity. investment bankers do look at capital structure before putting money in the ones i know even physically go to the company.

anyway thank you for your comments and also putting me right on the wacc and capm.