According to the moderate view of capital costs and financial leverage,as the use of debt financing increases,
A) the cost of capital continuously decreases.
B) the cost of capital remains constant.
C) the cost of capital continuously increases.
D) there is an optimal level of debt financing.

Question

Quizplus · Accepted Answer

According to the moderate view, the use of debt financing initially reduces the cost of capital due to the tax shield benefit. However, beyond a certain level, increasing debt leads to an increase in the cost of capital due to the higher probability of financial distress and bankruptcy. Therefore, there is an optimal level of debt financing, after which the cost of capital starts to increase.

According to the Moderate View of Capital Costs and Financial