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In which capital structure theory there is linier relationship between cost of equity and financial risk
Is it capmIn the traditional view of capital structure theory, there is a linear relationship between the cost of equity and financial risk.
This means that as financial risk (gearing) increases, the cost of equity also increases in a linear manner.
Modigliani and Miller Proposition 2 (with tax). According to this theory, as a company increases its level of debt (gearing), the financial risk to shareholders increases, which in turn increases the cost of equity.
This relationship is linear because the increase in financial risk due to higher gearing is directly proportional to the increase in the cost of equity.
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