Question

A company pays 7% interest on its debt. The higher the company’s tax rate,

	the higher the after-tax cost of debt.
	the lower the after-tax cost of debt.
	after-tax cost is unchanged.

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

Question 22 options:

	the existence of taxes.
	the existence of float costs.
	the existence of financial leverage.

The cost of preferred stock:

Question 23 options:

	goes up when you consider the tax effect.
	goes down when you consider the tax effect.
	is not effected by taxes.

Answer 1

1)

A company pays 7% interest on its debt. The higher the company’s tax rate, the lower the after-tax cost of debt

2)

The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of: the existence of float costs.

Float costs are legal costs that are incurred to issue the stock, it included underwriting fees, prospectus fees etc.

3)

The cost of preferred stock: is not affected by taxes.

Preferred stock is nothing but the distribution of profit, so it is not tax deductible