土豆妮

Ignoring any costs related to financial distress, if a firm increases its financial leverage, the value of the firm should:

A) increase because the FCFF will increase.

B) increase because the weighted average cost of capital will be lower due to interest tax shields.

C) decrease because the required rate of return on debt is lower than that of equity.

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When a firm adds leverage, its value may increase due to the tax shields on interest expense and the generally lower cost of debt. In theory, there is an optimal capital structure. If the amount of debt employed is greater than the optimal, the costs associated with risk of bankruptcy or financial distress begin to outweigh the advantage of interest tax shields.