Final answer:
Under perfect capital markets, the cost of capital is unaffected by the capital structure due to the Modigliani-Miller theorem. Only the risk of the firm's assets determines the cost of capital, and imperfections like taxes or asymmetric information are absent.
Step-by-step explanation:
The question relates to the theory of perfect capital markets, which posits that under certain ideal conditions, the cost of capital for a company should remain the same regardless of the company's capital structure. That is, whether a company is financed entirely through equity or through a mix of equity and debt (50% equity and 50% debt), the total cost of capital should be equal. This outcome is a core prediction of the Modigliani-Miller theorem, assuming the markets are perfect, meaning there are no taxes, bankruptcy costs, agency costs, or asymmetrical information and that individuals and corporations borrow at the same rates. In such a world, capital structure is irrelevant to the value of the firm, and the cost of capital is determined solely by the risk of the firm's underlying assets.
In a world with imperfect information, where there are differences in information between those managing a firm and outside investors, capital structure can play a role in signaling information to the market, potentially affecting the firm's value and the cost of capital. However, under the strict assumptions of perfect capital markets, these informational differences and capital structure decisions do not influence the firm's cost of capital.