Investors' required returns and the cost of equity capital ____ as the relative amount of debt used to finance the firm ____.
A) increase; increases
B) increase; decreases
C) remain constant; increases
D) remain constant; decreases

Question

Quizplus · Accepted Answer

Investors' required returns and the cost of equity capital increase as the relative amount of debt used to finance the firm increases. This is because a higher amount of debt increases the risk of default, making equity holders demand a higher return to compensate for the increased risk. As a result, the cost of equity increases, which in turn increases the required return of investors.

Investors' Required Returns and the Cost of Equity Capital ____