According to the graph of WACC for Union Pacific, which of the following is (are)true?
I.The cost of equity is an increasing function of the debt-equity ratio.
II.The cost of debt is an increasing function of the debt-equity ratio.
III.The weighted average cost of capital (WACC)is a decreasing function of the debt-equity ratio.
A)I only
B)I and II only
C)III only
D)I, II, and III

Question

Quizplus · Accepted Answer

The cost of equity typically increases with the debt-equity ratio because as a company takes on more debt, the risk to equity holders increases, leading to a higher required return. Similarly, the cost of debt can increase with the debt-equity ratio as more debt raises the company's financial risk, making new debt more expensive. The WACC initially decreases as debt is cheaper than equity due to tax shields, but beyond a certain point, the increasing costs of debt and equity due to higher risk can cause the WACC to increase.

According to the Graph of WACC for Union Pacific, Which