REVEALED PREFERENCE METHODS AND THE PURE THEORY OF THE COST OF CAPITAL.

The article draws upon the theory of revealed preference (RP) to evaluate the impact changes in capital structure can have on a firm's cost of capital. After using RP to derive Modigliani and Miller's famous proposition regarding the indifference of firm value to capital structure, the author details how a shift in capital structure implies equal but offsetting effects that leave share value unchanged. He also examines the consequences of lending and borrowing in different debt markets. Additional topics include optimal debt policy and weighted average cost of capital.