Which of the following statements is true regarding the relationship between the firm's cost of debt and its capital structure (as measured by the debt ratio)?
A) The range of debt ratios where the cost of debt begins to increase rapidly varies by firm and industry, depending on the level of business risk.
B) The precise relationship between the cost of debt and the debt ratio is simple to determine.
C) The relationship is a saucer-shaped curve.
D) The relationship is determined by the static tradeoff theory.

Question

Quizplus · Accepted Answer

The range of debt ratios where the cost of debt begins to increase rapidly varies by firm and industry, depending on the level of business risk. This is due to the fact that investors become increasingly concerned about default risk as a firm takes on more debt, causing the cost of debt to rise more rapidly past a certain point. Hence, the relationship between the cost of debt and the debt ratio is not simple and varies across firms and industries.

Which of the Following Statements Is True Regarding the Relationship