I don\'t understand the formula and the diagram below. Can someone please explai

Question

I don't understand the formula and the diagram below. Can someone please explain for me. Like, "D' represent what? Meaning of VL=VU+fd-(PVfd-PVac) and MBD , MCD, MCDAC and also brief explanation on the graph please. Thanks.



Incomplete answer for (Question : Discuss how the optimum capital structure is derived based on the concept of agency theory. A diagram would be useful.):

VL=VU+fd-(PVfd-PVac)

If,


MBD > MCD --> + D

MBD < MCD --> - D

MBD = MCD --> Optimum D

MBDAC< MCDAC --> - D

Explanation / Answer

I dont know all of the acronyms in the question, but this should get you started:

1) D stands for debt (in the capital structure)
2) Vl stands for Value of the levered firm

3) Vu stands for value of unlevered firm

4) I am guessing that PVac stands for present value of agency costs

The graph to me shows the relationship between the debt in the capital structure (in the form of debt/equity ratio) and the dollar value of agency costs. So, an increasing debt to equity level increases agency costs.

the If, then (MBD > MCD --> + D, etc) is prescribing what you should do to obtain the optimal debt level.

Hope that helps.

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