In the MM model, as the proportion of debt in the capital structure increases, the cost of equity:
A)increases.
B)decreases.
C)remains unchanged; there is no relationship between the two.
D)initially rises rapidly, then increases slowly beyond some point.

Question

Quizplus · Accepted Answer

According to the MM model, the cost of equity is a linear function of the proportion of debt in the capital structure. The more debt a company has, the higher the risk for equity investors, causing them to require a higher return on their investment. Therefore, as the proportion of debt increases, the cost of equity increases too.

In the MM Model, as the Proportion of Debt in the Capital