Given taxes and bankruptcy costs exist,as financial leverage increases,the weighted average cost of capital first decreases and then increases.

Question

Quizplus · Accepted Answer

The decrease in cost of capital occurs because debt is cheaper than equity due to tax deductibility of interest payments. However, as the leverage increases beyond a certain point, the bankruptcy risk also increases, leading to higher bankruptcy costs and hence, an increase in the cost of capital.

Given Taxes and Bankruptcy Costs Exist,as Financial Leverage Increases,the Weighted