Association for Financial Professionals (AFP) 2025 – 400 Free Practice Questions to Pass the Exam

Question: 1 / 400

The issuance of additional debt can affect which of the following?

WACC (it lowers cost in a linear fashion)

Stock value (it is diluted to a point, then rises)

Stock value (the value is diluted)

WACC (it will lower to a point, then rise)

The correct choice recognizes the relationship between a company's capital structure and its weighted average cost of capital (WACC). When a company issues additional debt, it often benefits from the tax shield that debt financing provides, which can lower the WACC. This happens because debt typically has a lower cost compared to equity, especially when interest rates are favorable.

However, as more debt is issued, the company's financial risk increases, which can lead to a higher cost of debt and potentially increase the WACC beyond a certain point. This creates a U-shaped relationship where WACC initially decreases with more debt but will begin to rise after a certain level due to the increased risk of financial distress perceived by investors and creditors.

Thus, the scenario outlined captures that balance — the initial lowering of WACC followed by an increase as debt levels become excessively high and the associated risks rises.

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