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The cost of equity capital in the form of new common stock will be higher than...

The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of

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Answer #1

There is cost associated with retained earnings because of the opportunity cost associated of them being retained and not paid out as dividends. Investors could well invest elsewhere to derive a return for the similar risk taken. However, there is no external cost factor associated with this.

On the other hand, cost of equity for new shares means paying floatation costs to the underwriters. These include costs associated with administrative and processing costs. Issuing new shares is a cumbersome process which requires the service of investment banks, lawyers, regulators and other key stakeholders. This comes at a cost.

Hence, cost of equity for new shares are more than cost of retained earnings.

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