Which of the following statements is CORRECT? a. The component cost of preferred

Question

Which of the following statements is CORRECT? a. The component cost of preferred stock is expressed as rp(1 T), because preferred stock dividends are treated as fixed charges, similar to the treatment of interest on debt. b. The cost of new equity (re) could possibly be lower than the cost of retained earnings (rs) if the market risk premium, risk-free rate, and the company's beta all decline by a sufficiently large amount. c. In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income. d. Its cost of retained earnings is the rate of return stockholders require on a firm's common stock. e. We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company's WACC for capital budgeting purposes.

Explanation / Answer

Option D is correct.

The cost of retained earnings is the minimum required return on firm’s common stock. This cost is slightly lower than cost of common stock due to no flotation cost. Most of times, cost of new common stock is the cost of retained earnings adjusted for flotation costs to be incurred on the issue of new shares.

Related Questions

Navigate

• Browse (All)
• Browse W
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.