I’m struggling to understand what seems like a perverse outcome of the MM proposition II without taxes.

MM-II ** without taxes** states that as the ratio of debt increases, the cost of equity will increase proportionally to offset the lower cost of debt and maintain the same WACC as the unlevered company. So far this is logical.

What is confusing is the following example:

Suppose we have two companies, A and B, both with a required rate of return (WACC) of 10.0%, and both financed equally by debt and equity. Company A has a cost of debt of 4.0% and company B has a cost of debt of 8.0%. Based on the equation:

r_{e} = r_{0} + (r_{0} - r_{d}) x (D / E) [equation (4) in the text page 97].

We get a cost of equity for **company A of 16.0%** and a cost of equity for **company B of 12.0%**. Surely this can’t be correct? All else being equal, a company with a higher cost of debt funding should be *more* risky for the equity holders than the same company with a lower cost of debt. Is there something I am missing? Appreciate any thoughts.