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.

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Definitions:

Xylem

The vascular tissue that conducts water and dissolved minerals in plants.

Phloem

The vascular tissue in plants responsible for transporting sugars and other metabolic products downward from the leaves.

Vascular Tissue

The specialized tissue in plants that conducts water and nutrients through the plant body, comprising mainly of xylem and phloem.

Lignin

A substance found in many plant cell walls that confers rigidity and strength, particularly in woody tissues.