What does the Modigliani and Miller theory suggest regarding WACC and gearing?

The Modigliani and Miller theory, particularly under the assumption of a world without taxes, transaction costs, or bankruptcy costs, introduces the idea that a company's overall cost of capital, referred to as the Weighted Average Cost of Capital (WACC), remains constant regardless of how much debt (gearing) it utilizes.

According to the proposition, as a firm takes on more debt, the cost of equity rises due to increased financial risk; however, this increase in the cost of equity precisely offsets the benefits of cheaper debt financing. Hence, the firm's total WACC does not change, suggesting that the capital structure (the proportions of debt and equity) does not affect the firm's value or its overall cost of capital.

In practical terms, this means that investors are indifferent to the mix of debt and equity financing, as the returns required on equity and debt adjust in such a way that the overall cost remains the same, thereby validating the conclusion that WACC stays constant regardless of levels of gearing.