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Reply to Linnenluecke, Shen, Smith, Zhu, and Liang (2020)

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  • David Johnstone

Abstract

When the firm changes its operating leverage it becomes a different firm with a different payoff distribution from its operations. Its CAPM market value can therefore be higher or lower, as can its cost of capital. Its market value is not independent of its operating leverage in the way that its firm value is independent (under MM) of its debt to equity financing ratio. Changes in debt to equity do not affect the firm's operations, whereas changes in operating leverage are designed to do exactly that.

Suggested Citation

  • David Johnstone, 2020. "Reply to Linnenluecke, Shen, Smith, Zhu, and Liang (2020)," Abacus, Accounting Foundation, University of Sydney, vol. 56(2), pages 292-294, June.
    • Handle: RePEc:bla:abacus:v:56:y:2020:i:2:p:292-294
    DOI: 10.1111/abac.12192
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    References listed on IDEAS

    as
    1. Fama, Eugene F., 1977. "Risk-adjusted discount rates and capital budgeting under uncertainty," Journal of Financial Economics, Elsevier, vol. 5(1), pages 3-24, August.
    2. Richard Lambert & Christian Leuz & Robert E. Verrecchia, 2007. "Accounting Information, Disclosure, and the Cost of Capital," Journal of Accounting Research, Wiley Blackwell, vol. 45(2), pages 385-420, May.
    3. David Johnstone, 2016. "The Effect of Information on Uncertainty and the Cost of Capital," Contemporary Accounting Research, John Wiley & Sons, vol. 33(2), pages 752-774, June.
    4. David Johnstone, 2017. "Sensitivity of the Discount Rate to the Expected Payoff in Project Valuation," Decision Analysis, INFORMS, vol. 14(2), pages 126-136, June.
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