In the traditional approach to capital structure, as the amount of debt increases in a firm's capital structure,
A) the cost of equity rises faster than the cost of debt.
B) the cost of debt rises faster than the cost of equity.
C) equity cost is unaffected.
D) debt becomes less risky.

Question

Quizplus · Accepted Answer

As a firm increases its debt, the financial risk to equity holders increases, causing the cost of equity to rise faster than the cost of debt due to the increased risk premium demanded by equity investors.

In the Traditional Approach to Capital Structure, as the Amount