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Answer (D) is correct . The U-shaped curve indicates that the cost of capital is quite high when the debt-to-equity ratio is quite low. As debt increases, the cost of capital declines as long as the cost of debt is less than that of equity. Eventually, the decline in the cost of capital levels off because the cost of debt ultimately rises as more debt is used. Additional increases in debt (relative to equity) will then increase the cost of capital. The implication is that some debt is present in the optimal capital structure because the cost of capital initially declines when debt is added. However, a point is reached (e) at which debt becomes excessive and the cost of capital begins to rise.

Answer (A) is incorrect because The composition of the capital structure affects the cost of capital since the components have different costs.
Answer (B) is incorrect because The cost of debt does not remain constant as financial leverage increases. Eventually, that cost also increases.
Answer (C) is incorrect because Increased leverage is initially favorable.