Although the after-tax cost of debt is below the cost of equity, firms cannot increase their use of debt to endless amounts.

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Firms have a limit on how much debt they can take on before it becomes too risky and potentially harmful to their credit rating and financial stability. Additionally, debt payments are contractual obligations that must be met, while equity is not obligated to receive dividends or gains. Therefore, a balance must be struck between the use of debt and equity financing.

Although the After-Tax Cost of Debt Is Below the Cost