yospaghetti

I'm thinking that the reasoning in the Schweser example would be that if a firm issues more debt, they will thus take on more interest expenses etc. This makes the firm less profitable and as a result the premium required on the return of equity increases. Debt claims will come before equity claims and could be another reason why the required equity risk premium would increase. Lastly, the cost of debt and wcc include the tax shield that comes with debt financing. Check out in which context Schweser says that the equity return requirement is more sensitive. The tax shield is a positive thing up until we reach the threshold. For more info on this check out the MM Theories...