Series 79 practice questionmediumOptimal Leverage
An investment banker is helping a client determine its optimal capital structure. Which of the following is most likely to occur if a company increases leverage beyond the optimal point?
- AThe cost of equity and WACC both increase.✓ Correct answer
- BThe cost of debt decreases while WACC remains unchanged.
- CThe company’s beta declines.
- DWACC will decrease further.
Explanation
Why A — The cost of equity and WACC both increase.
Beyond the optimal point, additional debt increases financial risk, raising both the cost of equity and WACC. Cost of debt generally rises (not falls), beta increases with risk, and WACC does not continue to fall.
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