What happens to the costs of debt and equity when leverage increases? Explain.

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What happens to the costs of debt and equity when leverage increases? Explain.

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What happens to the costs of debt and equity when leverage increases? Explain.

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Increase in leverage that is debt equity ratio leads to an increase in both cost of capital and equity. In the beginning it increases at decreasing rate and then starts increasing at increasing rate. This increase is due to the increase in leverage leading to the probability of financial distress and also increase in beta.

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