As the need for capital increases beyond the optimum capital structure, the cost of debt financing will ________ the firm's weighted average cost of capital.
A) increase, lowering
B) increase, raising
C) decrease, lowering
D) decrease, raising

Question

Quizplus · Accepted Answer

As the need for capital increases, the firm may have to resort to issuing more debt to meet its financing needs. However, as the level of debt increases, the risk of default also increases, which in turn leads to an increase in the cost of debt financing. This increase in the cost of debt financing will raise the firm's weighted average cost of capital, as the cost of debt is one of the factors that goes into calculating the WACC. Therefore, option B, "increase, raising", is the best choice.

As the Need for Capital Increases Beyond the Optimum Capital