Market Price of Shares
In Example, let us suppose the firm with Rs 2 lakh debt has 2,000 equity shares (of Rs 100 each) outstanding. The firm has issued additional debt of Rs 1,00,000 to repurchase its shares amounting to Rs 1,00,000; it has to repurchase 1,000 shares of Rs 100 each from the market. It, then, has 1,000 equity shares outstanding, having total market value of Rs 1,00,000. The market price per share, therefore, is Rs 100 (Rs 1,00,000 + 1,000) as before.
In the second situation the firm issues, 1,009. equity shares of Rs 100 each to retire debt aggregating Rs 1,00,000. It will have 3,000 equity shares outstanding, having total market value of Rs 3,00,000, thus, giving a market price of Rs 100 per share.
Thus, we note that there is no change in the market price per share due to change in leverage. We have portrayed the relationship between the leverage and the various costs.
The graph is based on Example. Due to the assumption that ko and kr remain unchanged as the degree of leverage changes, we find that both the curves are parallel to the X-axis. But as the degree of leverage increases, the ke increases continuously.