Final answer:
The weighted average cost of capital increases with higher debt levels due to financial distress costs. Interest rates decline when there is a rise in the supply of capital, while the quantity of loans increases with a rise in demand or supply. The correct answer is d) Financial distress costs.
Step-by-step explanation:
The weighted average cost of capital (WACC) rises at higher levels of debt due to financial distress costs. When a company increases its debt, the risk of financial distress also increases. These risks include the possibility of bankruptcy, higher interest rates, and the costs associated with financial distress such as legal fees and reorganization costs. Higher debt levels lead to a higher perceived risk by investors and lenders, which in turn increases the cost of capital.
Financial Market Changes Affecting Interest Rates and Loan Quantities
A decline in interest rates in the financial market is typically caused by a rise in the supply of funds, such as when banks have more capital to lend. Conversely, an increase in the number of loans made and received can result from either a rise in demand for loans or a rise in the supply of loanable funds. Enhanced supply of funds tends to lower interest rates and facilitate more borrowing and lending activities. The correct answer is d) Financial distress costs.