What is the WACC 'U-curve', and why does it exist?

WACC vs. leverage has a U-shape: high at low leverage (too little tax shield), falls as leverage rises (the tax shield dominates), reaches a minimum at the 'optimal D/E', then rises again (distress costs exceed the tax-shield benefit). Optimal point: typically 30–50% debt-to-total-capital for industrial companies. Theory: a trade-off between the tax shield (linearly positive) and distress risk (convexly rising). In practice: bankers rarely estimate the 'optimum' exactly — they anchor on the industry median or management guidance.