Question

A basic assumption of traditional cost of capital analysis is the ________________________.

• A. The firm's business and financial risks are unaffected by the acceptance and financing of projects
• B. The firm/s financial risks are affected by the acceptance and financing of projects
• C. The cost of capital can be explicit or implicit
• D. None of the above

Answer 1

Answer: (A)

The firm's business and financial risks are unaffected by the acceptance and financing of projects

The Traditional Theory of Capital Structure says that for any company or investment there is an optimal mix of debt and equity financing that minimizes the WACC and maximizes value. Under this theory, the optimal capital structure occurs where the marginal cost of debt is equal to the marginal cost of equity.