ACCA FM · Chapter 12 · Question 1 of 9
According to the traditional view of capital structure, which of the following is correct?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: D) There is an optimal level of gearing at which the weighted average cost of capital is minimised
Explanation
The traditional view holds that as gearing rises from zero, the benefit of cheaper debt initially outweighs the rise in the cost of equity, so WACC falls. Beyond a certain point, the cost of equity (and eventually debt) rises sharply, so WACC increases. There is therefore an optimal capital structure where WACC is lowest.
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