The optimal capital structure: (3) debt and % equity with a cost of capital of % b. Why does the cost of capital initially decline as the firm substitutes debt for equity financing? The cost of capital initially declines because the firm cost of debt is than the cost of equity. c. Why will the cost of funds eventually rise as the firm becomes more financially leveraged? As the firm becomes more financially leveraged and riskier, the cost of debt and equity will and cause the cost of capital to increase. d. Why is debt financing more common than financing with preferred stock? Debt financing is more common than financing with preferred stock because of A which makes the cost of the debt financing the cost of the preferred stock. e. If interest were not a tax-deductible expense, what effect would that have on the firm's cost of capital? If interest were not a tax deductible, the cost of debt would be the cost of capital