[amp_mcq option1=”Remains constant up to a degree of leverage and rises sharply thereafter with every increase in leverage” option2=”Rises constantly with increase in leverage” option3=”Decrease up to certain point, remains unchanged for moderate increase in leverage and rises beyond a certain point” option4=”Decrease at an increasing rate with increase in leverage” correct=”option3″]<\/p>\n
The correct answer is: C. Decrease up to certain point, remains unchanged for moderate increase in leverage and rises beyond a certain point.<\/p>\n
The traditional approach to capital structure analysis assumes that the cost of debt is fixed and the cost of equity increases with leverage. This is because as a company borrows more money, it becomes more risky, and investors demand a higher return to compensate for that risk.<\/p>\n
The average cost of capital (WACC) is a weighted average of the cost of debt and the cost of equity. The WACC is used to calculate the return that a company needs to earn on its investments in order to satisfy its investors.<\/p>\n
The WACC curve is a graph that shows how the WACC changes as a company’s leverage increases. The WACC curve is U-shaped, with the lowest point on the curve occurring at the optimal level of leverage.<\/p>\n
The optimal level of leverage is the level of debt that minimizes the WACC. At the optimal level of leverage, the tax shield from debt financing offsets the increase in the cost of equity.<\/p>\n
Beyond the optimal level of leverage, the WACC increases as leverage increases. This is because the increase in the cost of equity outweighs the tax shield from debt financing.<\/p>\n
Here is a brief explanation of each option:<\/p>\n
[amp_mcq option1=”Remains constant up to a degree of leverage and rises sharply thereafter with every increase in leverage” option2=”Rises constantly with increase in leverage” option3=”Decrease up to certain point, remains unchanged for moderate increase in leverage and rises beyond a certain point” option4=”Decrease at an increasing rate with increase in leverage” correct=”option3″]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[945],"tags":[],"class_list":["post-45857","post","type-post","status-publish","format-standard","hentry","category-financial-management","no-featured-image-padding"],"yoast_head":"\n