Question

Rank the following from highest to lowest for the typical company.

rs, the cost of retained earnings WACC,

the Weighted Average Cost of Capital re,

the cost of a new equity issue rd(1-Tc),

the after tax cost of debt

Answer 1

re > rs > WACC > rd(1-Tc)

cost of debt has to be lower than the cost of equity or retained earnings otherwise it is not advantageous for the firm. so cost of debt after tax is the least costly.

rs = cost of retained earning. there are no flotation costs involved in calculating rs. so it is lower than that of re, the cost of new equity capital

re = involves flotation costs and so it is costlier than rs.

wacc = weighted average cost and so it has to be higher tahn cost of debt after tax but lower than rs

so the sequence is re > rs > WACC > rd(1-Tc)

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