1. Do cost of debt and cost of equity increase monotonically when more debt is taken?...

1. Do cost of debt and cost of equity increase monotonically when more debt is taken? Why?

2. Does WACC increase monotonically when more debt is taken? Why?

Solutions

Expert Solution

1.No cost of equity and cost of debt does not change monotonically as leverage increases because it is most probably assumed that as the debt increases the weighted average cost of capital of a company decreases.

So this assume that more leverage decreases the weighted average cost of capital, because of the tax shield advantages associated with it and it thereby reduces the cost of overall equity as cost of equity is generally higher than cost of debt.

This can also be attributed to the return on equity, if the return on Capital is higher than the overall cost of capital, then cost of debt would be lower and it will add to the overall profit of the firm, thereby, reducing the cost of equity too.

if more debt is to be raised and if it is raised at the earlier cost of debt, then the cost of overall debt will still remain constant, if it is raised at Higher price then cost of debt will increase, if it is raised at lower price than earlier cost, then cost debt will decrease.

jeff jeffy answered 1 year ago

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