Which of the following statements is CORRECT?
A) Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC.
B) Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing.However, this action still may raise the company's WACC.
C) Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing.However, this action still may lower the company's WACC.
D) Since a firm's beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity.
E) Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.

Question

Quizplus · Accepted Answer

Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing due to increased financial risk for investors. However, this action still may lower the company's WACC as debt is a cheaper source of financing than equity. The optimum debt-to-equity ratio to minimize WACC varies depending on the company and industry.

Which of the Following Statements Is CORRECT