Suppose you plotted a curve which showed a Firm U's WACC on the vertical axis and its debt ratio on the horizontal axis.Then you plotted a similar curve for Firm V.The curve for firm U resembled a shallow "U," while that for Firm V resembled a sharp "V." Both firms have debt ratios that cause their WACCs to be minimized.Other things held constant,it would be easier for Firm V than for Firm U to maintain a steady dividend in the face of varying investment opportunities and earnings from year to year.

Question

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Firm U could fund its capital budget with varying amounts of debt without causing large changes in its WACC and thus in its value and stock price.Firm V could not vary its debt ratio without increasing its WACC.Thus,Firm V would have to raise and lower its dividend payout in order to obtain the equity it needed to support its capital budget.Firm U,on the other hand,could maintain a stable,steady dividend,and let the debt ratio vary without causing much harm to its stock price.

Suppose You Plotted a Curve Which Showed a Firm U's