Which of the following statements is true concerning debt that has no risk of default?
A)A company's cost of capital increases as more debt is used in its capital structure.
B)The cost of debt increases as more debt is used in the company's capital structure.
C)The cost of debt increases as more debt is used in the company's capital structure because total risk increases.
D)The cost of equity capital increases with increasing proportions of debt because,although the total amount of risk does not change,risk is concentrated on a proportionately smaller amount of equity capital.

Question

Quizplus · Accepted Answer

The cost of equity capital increases with increasing proportions of debt because, although the total amount of risk does not change, the risk is concentrated on a proportionately smaller amount of equity capital. This is known as the leverage effect, where the use of debt magnifies the returns to equity holders but also increases their risk, even if the debt itself has no risk of default.

Which of the Following Statements Is True Concerning Debt That