Which of the following statements is CORRECT?
A)When a company increases its debt ratio, the costs of equity and debt both increase.Therefore, the WACC must also increase.
B)The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share.
C)All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio.
D)Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.
E)Since debt is cheaper than equity, increasing a company's debt ratio will always reduce its WACC.

Question

Quizplus · Accepted Answer

C is correct because an increase in the corporate tax rate would increase the tax savings from interest payments, making debt more attractive to corporations. A is incorrect because an increase in the debt ratio would increase the cost of equity due to higher financial risk, but it could potentially decrease the cost of debt due to the tax shield. B is incorrect because maximizing earnings per share does not necessarily maximize the stock price, as shareholders are also concerned with risk. D is incorrect because while increasing debt raises financial risk, it also decreases the cost of capital up to a certain point, which means the WACC could potentially decrease initially. E is incorrect because while debt may be cheaper than equity, it also involves higher risk and interest payments, which means the optimal capital structure may involve a combination of both debt and equity.

Which of the Following Statements Is CORRECT