The weighted average cost of capital (WACC)declines as more of the lowest cost component is added.What limits a firm from using nearly all debt is that as the debt-to-assets ratio rises,the absolute interest expense gets very large.The large interest expense reduces income and results in a debt-to-assets ratio limit even though the WACC continues to decline.

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Quizplus · Accepted Answer

The WACC does not necessarily continue to decline as more debt is added. While initially adding low-cost debt can reduce the WACC, beyond a certain point, the cost of debt increases due to the higher risk of default. This increased risk leads to higher interest rates demanded by lenders, which can increase the WACC. Additionally, the risk of financial distress and bankruptcy costs also limit the amount of debt a firm can use, contrary to the statement that the WACC continues to decline with more debt.

The Weighted Average Cost of Capital (WACC)declines as More of the Lowest