Which of the following statements is CORRECT? Since debt capital can cause a com
ID: 2769736 • Letter: W
Question
Which of the following statements is CORRECT? Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes. If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject. Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt. Higher flotation costs tend to reduce the cost of equity capital.
Explanation / Answer
Correct Statement :
Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt. Higher flotation costs tend to reduce the cost of equity capital.
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