Question

Which of the following rankings, from lowest to highest, is highly accurate?

	a.	cost of debt, cost of preferred stock, cost of common stock, cost of retained earnings
	b.	cost of common stock, weighted average cost of capital, cost of debt
	c.	cost of new common stock, cost of preferred stock, cost of debt, cost of internal equity
	d.	cost of debt, weighted average cost of capital, cost of common stock

Answer 1

Option D,

Cost of debt will be lower as the claim of debt issuer is first with lower risk, lower risk implies to lower return also, interest payment on debt is tax deductible. Hence effectively cost of debt will be rd*(1-T)

Weighted average cost of capital- is the weighted average cost for debt as well as other funding I.e. preferred stock and common stocks etc. Since the cost of common stock is for the prorotion of the weight of the common stock

WACC= Wd * rd*(1-Td)+ WCE*RCE

The cost of common stock will be higher in this case as the risk is higher that implies higher cost for this type of funding and this is not tax deductible.