Question

which of the following statements with respect to the WACC is correct? a. retained earnings are...

which of the following statements with respect to the WACC is correct?

a. retained earnings are not included in the wacc since they provide free finds to any company

b. none are correct

c. flotation costs are included in the wacc if the company uses internal funds (retained earnings) but are irrelevant if the company relies on external funds (new common stock)

d. the required rate of return on outstanding common stocks is a reasonable estimate of the cost of retained earnings (opportunity cost)

e. since flotation costs reduce the wacc most firms prefer to issue new stocks instead of retained earnings

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Answer #1

Answer - Option d

Option a is incorrect. Retained earnings are included in WACC, with cost of equity used.

Option c is incorrect. Floatation costs are included in WACC when firm raises funds from external sources, and are not included when the firm uses funds from internal sources.

Option e is incorrect. Floatation costs increase the overall cost of capital.

Option d is correct. Required rate of return on outstanding common stocks is used as estimate for cost of retained earnings.

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