...about the visual program
The axes' labels:
You can vary the corporate tax rate and debt:equity ratio in order
see how taxes and changes in financing strategy will affect the
cost of capital and thus, the decisions made by managers. As
the corporate tax rate increases, managers will be more likely
to use debt financing other things being equal. The plane
represents the set of points we might expect to occur. Note that in
the real world, a firm's bonds almost always pay less
than its stock. Therefore the visual program removes situations
in which rD > rE by marking them invalid.
- rE....The return on the firm's equity. In other words, the price
the firm pays to attract investors to purchase its stock.
- rD....The return on the firm's debt. In other words, the price
paid to bondholders.
- r*....The Weighted Average Cost of Capital