Question 4: Capital Structure Theorems

Unlevered Corp. is a young public company that is financed with 100% equity. A consultant has advised the firm to change its capital structure to more debt and less equity. Using the Trade-off (Static) Theory of Capital Structure, please explain the possible impact of increasing financial leverage (i.e, debt financing) on the firm's weighted average cost of capital (WACC). Make sure to explain your reasoning, but please limit your discussion to the assumptions and propositions of the Trade-off Theory