CEVAP:

The model assumes that the cost of debt, the WACC and the value of the firm is irrespective of financial leverage. The value of the firm is its net operating income which is also independent of leverage, capitalized at the constant WACC. Therefore, the firm value will remain unchanged by the financing decisions under the assumption of no corporate taxes. The cost on the borrowings is a constant no matter the amount of debt capital. However, utilizing higher levels of financial leverage in the capital mix increases the risk borne by the shareholders. As a result, the cost of equity rises relative to the increase in leverage, but the
rise in the cost of equity is offset by the lower cost on the borrowings.
Hence, the WACC remains constant at all possible levels of leverage