Question

Which of the following statements is correct?

	a.	The WACC should include only after-tax component costs. Therefore, the required rates of return (or "market rates") on debt, preferred, and common equity (rd, rps, and rs or e) must be adjusted to an after-tax basis before they are used in the WACC equation.
	b.	When the MCC schedule is developed, the first break point always occurs as a result of using up retained earnings.
	c.	If a company with a debt-to-assets ratio of 50 percent were suddenly exempted from all future income taxes, then, all other things held constant, this would cause its WACC to increase.
	d.	Preferred stock is riskier to investors than is debt. Therefore, if someone told you that the market rates showed rd > rps for a given company, that person must have made a mistake.
	e.	The cost of retained earnings is generally higher than the cost of new common stock.

Answer 1

Option c is correct option because if taxes were removed then interest on debt would lose its tax deductible portion. Thereby increasing its WACC or cost of capital.

Option a is wrong because equity and preferred stock are not tax deductible . Only debt is tax deductible.

Option b is wrong In Marginal cost of capital schedule retained earnings doesnot develop first break point.

Option d False because more is the risk higher is the required. Higher the risk of preferred stock causes higher returns. over debt.

Option e. is wrong Since retained earnings has no flotation or issuance cost hence it is less than cost of equity.