If Interest Expense Lowers Taxes, Why Does the WACC Not

question 116

Multiple Choice

If interest expense lowers taxes, why does the WACC not decrease indefinitely with the addition of more debt?

• A) The tax shield effect of debt will result in a lower cost of equity.
• B) Increasing debt too much can result in a greater likelihood of firm failure (financial distress).
• C) A firm's common stock price will not be affected by the amount of debt a firm uses.
• D) Too much common equity increases the probability of bankruptcy.

---

Definitions:

Viscous

A physical property indicating a fluid's resistance to flow; highly viscous substances move slowly.

Gas Bubbles

Cavities filled with gas trapped within a solid material, often found in cooling lava.

Magma Rise

The upward movement of molten rock or magma from the Earth's mantle towards the crust, often leading to volcanic activity.

Pressure Decreases

A phenomenon where the force exerted by a fluid per unit area decreases, commonly observed with increasing altitude in the atmosphere.