Question

Which choice would complete the following statement:

Under perfect capital markets, leverage has ________________ effect on firm value or overall cost of capital.

Select one:

a. No

b. Positive

c. Negative

d. Unpredictable

Answer 1

Option 'A' is correct

No

With perfect capital markets, Leverage has NO effect on firm value or overall cost of capital.

A perfect capital market is where when any of the investors have enough power to change the price of an asset and and all of them have access to the same information.

With perfect capital markets, as a firm increases its leverage, its debt and equity costs of capital both increase, but its weighted average cost of capital remains constant because more weight is put on the lower cost debt.