Cost of Debt and Cost of Capital Equity Assignment
Which of the following statements is CORRECT?
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.
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 after-tax 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 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. Get Finance homework help today