Which of the following statements best describes WACC?
A)Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.
B)Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC.
C)Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing. However, this action still may raise the company's WACC.
D)Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing. However, this action still may lower the company's WACC.

Question

Quizplus · Accepted Answer

Increasing a company's debt ratio generally increases the marginal cost of both debt and equity financing due to the higher financial risk. However, because debt financing is cheaper than equity financing due to tax deductibility of interest, this can still result in a lower overall Weighted Average Cost of Capital (WACC) up to a certain point.

Which of the Following Statements Best Describes WACC