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Under the Traditional Approach to capital structure:
AWACC is constant
BWACC first declines with debt, reaches a minimum, then rises
CWACC is irrelevant
DOnly equity is relevant
Answer & Solution
Correct answer: B. WACC first declines with debt, reaches a minimum, then rises
1. Traditional Approach: Ke rises slowly at first, Kd is constant.
2. WACC declines initially, reaches a minimum at optimal capital structure, then rises.
3. Implies an optimum debt-equity ratio exists.
_Source: ICAI BoS CA Inter Paper 6A, Ch 5 "Financing Decisions — Capital Structure", §2.2_