Asked by Gilberto Camacho on May 20, 2024
Verified
Since the component cost of debt is less than the component cost of equity, a shift in the composition of a firm's capital structure towards debt will always reduce a firm's cost of capital.
Component Cost Of Debt
The effective rate that a company pays on its current debt, incorporating both interest rates and other costs associated with borrowing.
Component Cost Of Equity
The rate of return that a company must offer investors to encourage investment in its equity, accounting for risk.
- Appreciate the role of debt and equity in affecting a firm's cost of capital.
Verified Answer
MR
Mohammad Rony HossainMay 26, 2024
Final Answer :
False
Explanation :
While the cost of debt is typically lower than the cost of equity, increasing debt also increases financial risk, which can lead to a higher cost of equity and potentially higher overall cost of capital if the firm becomes overly leveraged.
Learning Objectives
- Appreciate the role of debt and equity in affecting a firm's cost of capital.