A higher proportion of debt in the capital structure (other things equal) typically:
ADecreases WACC up to optimal point because debt is cheaper after tax
BIncreases WACC due to higher financial risk on equity
CHas no effect on WACC
DReduces total cost of capital indefinitely
Answer & Solution
Correct answer: A. Decreases WACC up to optimal point because debt is cheaper after tax
1. Debt is cheaper than equity (lower required return + tax shield).
2. Adding debt reduces WACC up to an optimal leverage point.
3. Beyond that point, financial distress and higher Ke push WACC up.
_Source: ICAI BoS CA Inter Paper 6A, Ch 4 "Cost of Capital", §10 + Ch 5 capital structure_
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