The capital structure that should be used to plan for next years capital program

Question

The capital structure that should be used to plan for next years capital program is the:

a. book value based capital structure

b. market value based capital structure

c. either the book value or the market value capital structure is satisfactory

d. neither the book value or the market value capital structure is satisfactory

The cost of equity from selling new stock is greater than the cost of retained earnings because

a. selling new stock decreases the earnings per share.

b. selling new stock increases the market price of the stock.

c. of the flotation costs.

d. dividends are increased.

If a firm will use only equity funds next year, the ____ is the correct discount rate to use in the capital budgeting models (NPV, etc.)

a. component cost of equity

b. weighted average cost of capital

c. historical cost of funds

d. all of the above are correct

Explanation / Answer

1. The capital structure that should be used to plan for next year’s capital program is the market value based capital structure

Therefore correct answer is option b. market value based capital structure

For the next year’s capital program, the market value based capital structure is used where adjusted market value reflects in components used to calculate cost of capital.

2. The cost of equity from selling new stock is greater than the cost of retained earnings because of the flotation costs

Therefore correct answer is option c. of the flotation costs

Flotation cost is the cost used to raise new fund from the market like underwriting fees, legal fees, registration fees etc. It is included into cost calculation of that security. And the cost of retained earnings has no such cost therefore its cost is lower in comparison of selling new stock.

3. If a firm will use only equity funds next year, the component cost of equity is the correct discount rate to use in the capital budgeting models (NPV, etc.)

Therefore correct answer is option a. component cost of equity

If a firm will use only equity funds next year, then there is no point in using weighted average cost of capital (WACC) as the weights of other types of fund are zero. Therefore the component cost of equity is the correct and appropriate discount rate to be used in the capital budgeting model.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

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