Does financing affects the market value of a company?

Corporation tax offers a valuable tax shield that allows interest payments on corporate debts to be deductible for income tax purposes. It enhances the firm’s value by lowering the cost of debt, thus lowering WACC.

The difference can be seen between two companies with similar pre-tax operating cash flows but different capital structure will differ in tax payments as debt offers a tax shield. Thus, the value of a levered company is higher than the unlevered company, which makes debt financing attractive.

Although Modigliani and Miller (Berk, 2011) argued that the market value of a company is not affected by the way it finance its investment, but debt finances increases bankruptcy risk thus causing financial distress. Therefore managers may choose to limit taking on too much debt finance. In the long run, investment and operating decisions are the main drivers in enhancing a firm’s market value. This implies the importance of maintaining a healthy liquidity to secure good investment opportunities