Question

Which of the following statements about capital structure is false? A In most situations, the use...

Which of the following statements about capital structure is false?

A In most situations, the use of debt financing increases the return to owners (say, as measured by ROE).
B In all situations, the use of debt financing increases the riskiness to owners.
C At some proportion of debt financing, the cost of debt levels offs and then decreases as more and more debt is added.
D Debt financing allows more of a business’s operating income to flow through to investors.
E Because debt financing “levers up” (increases) owners’ returns, its use is called financial leverage.
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Answer #1

Answer - At some proportion of debt financing, the cost of debt levels offs and then decreases as more and more debt is added.

Reason - increasing proportion of debt in capital structure doesn't decreases the cost of debt at all. Infact there is no relationship between adding more debt in capital structure and decrease of cost of debt. Cost of debt depends upon the risk free rate of return in the market which remains same irrespective of how much debt is added in any companies capital structure. So this option is incorrect about capital structure.

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