The point about debt being cheaper is from US textbooks because of their classical system of taxation of dividends. For an Aust small cap like AHE, where the marginal investor is probably a domestic holder, then the franking credits mean that there is no significant disadvantage with equity funding ie $1 of EBIT can be paid out entirely as $1 of interest expense and that $1 is taxed in the hands of the lender; $1 of EBIT can also be taxed at a corp tax rate of 30% leaving $0.7 to be paid out as a franked dividend which is then grossed up to $1 in the hands of an Aust holder with a $0.3 franking credit. Both the lender and shareholder end up with the same after tax return. Tax aside, the accepted theory is that cost of capital doesn't really change with gearing because higher gearing will raise the cost of equity and debt and vice versa. If this wasn't true then every company would have $1 of equity and be funded by debt. Sometimes there are anomolies which justify replacing equity with debt but none of those apply here. Most important point is that AHE has signalled that it looks favourably upon its Australian retail shareholders and that justifies a reduction in its equity risk premium.
AHE Price at posting:
$3.91 Sentiment: Buy Disclosure: Held
