1. For almost all companies, there exists an optimal capital structure. This is because of which of these reasons?

I. Because debt is always cheaper than equity, debt always lowers overall costs of capital.

II. Too much debt can cause the firm to take on too much fixed costs which leaves it vulnerable to a downturn, but too little debt results in a high cost of capital.

III. There is a tax shield benefit to increased leverage.

IV. Debt is easier to raise and creates better financial flexibility.

1. All of the above are reasons.
2. Only I and II.
3. Only III and IV.
4. Only II, III, and IV
5. Only I, II and III

2. An increase in a firm's debt ratio can cause

I. a decline in the firm's P/E ratio because of increased costs and increased risk.

II. an increase in the firm's beta as risk rises.

III. a decline in the firm's weighted average cost of capital, up to a point.

IV. an increase in the cost of equity eventually if leverage gets too high.

a. All are affects

b. None are affects

c. Only I, II and III.

d. Only IV

e. Only I and IV.