The market risk premium is 6.1%. Previous question Next question Get more help from Chegg. Jury's dividend growth rate is 8%, and flotation cost is $1.25. Course. The cost of retained earnings 1.The cost of raising capital through retained earnings is _____ (a. less than, b. greater than) the cost of raising capital through issuing new common stock 2. The company is raising money in order to make an investment. Retained earnings a. have no cost b. are the firm's cheapest source of funds c. have a cost that equals the cost of capital d. are cheaper than the cost of new common stock d 5. There are no floatation costs for retained earnings whereas there is a floatation cost of 2 to 10% or sometimes even more for additional external equity. University. Dividend Payout Ratio: The percentage of the net income that will be distributed as dividends. The firm could sell, at par, $100 preferred stock that pays a 12% annual dividend, but flotation costs … b. the cost of retained earnings is A) the cheapest B)zero becasue the firm does not have to pay intrest or dividends itself C)always less then the common new stock D)typically cheaper then the cost of preffered stock - 465935 The cost of retained earnings in a firm's capital structure is: 1. the cheapest component cost zero because the firm does not have to pay interest or dividend to itself always more than the cost of new common stock always less than the after tax cost of debt none of the above B)zero becasue the firm does not have to pay intrest or dividends itself. Explain in words why new common stock has a higher cost than retained earnings. D’Amico Co. has a beta of 0.87. The current risk-free rate of return is 3.8%. Cost of new equity is the cost of a newly issued common stock that takes into account the flotation cost of the new issue. c. The cost of new equity (r e ) could possibly be lower than the cost of retained earnings (r s ) if the market risk premium, risk-free rate, and the company’s beta all decline by a sufficiently large amount. Cost of Retained Earnings (RE) are the accumulated portion of a business's profits that are not distributed as dividends to shareholders but instead are reserved for reinvestment back into the business. The before-tax cost of debt is 6.0%, the cost of preferred is 8.0%, and the cost of retained earnings is 13.0%. chapter 11 cost of capital chapter 11 cost of capital multiple choice questions the cost of capital is used as discount rate because: it is an indication of how. The cost of new common stock financing is higher than the cost of retained earnings due to _____. The cost of common stock (paid-in capital and retained earnings) is considered to be the most expensive component of the cost of capital because of the risks involved. Assume that a corporation has the following: $40 million of long-term debt with an after-tax cost of 4%; $10 million of 7% preferred stock The cheapest source of finance is (a) debenture (b) equity share capital (c) preference share (d) retained earning The activities may include increasing the working capital, financing expansion projects, replacing plant and machinery etc. On the contrary its the most expensive. Explain why retained earnings are not free and use three approaches to estimate the component cost of retained earnings. Which of the following statements is CORRECT? Best Answer . Example of Cost of Capital. Its cost of retained earnings is the rate of return stockholders require on a firm's e. The component cost of preferred stock is expressed as rp(1 -T), because interest on debt. You were hired as a consultant to a company, whose target capital structure is 50% debt, 0% preferred, and 50% common equity. After we have calculated each component cost of capital, we will calculate a weighted average based on the relative market values of each component. University of Windsor. The cost of retained earnings is determined based on the opportunity rate of earnings of equity shareholders which is being forgone continuously. The cost of equity capital in the form of new common stock will be higher than the cost of retained earnings because of: A) the existence of taxes. Cost of Debt. Cost of common F I Answer a EASY 10 The cost of common equity obtained by from FIN FIN4345 at Florida International University Companies normally retain 30 per cent to 80 percent of profit after tax for financing growth. Generally, no, but it technically depends on your weighted average cost of capital, as well as some other complicating factors. Sign in Register; Hide. The overall cost of capital depends on the cost of each source and the proportion of each source used by the firm. Assume the firm has insufficient retained earnings to fund the equity portion of its capital budget. Thus, the relevant component costs are today’s marginal costs rather than historical costs. Answer: [Show S10-23 here.] A) the cheapest. Select one: a. flotation costs and overpricing b. flotation costs and underpricing c. commission costs and overpricing d. flotation costs and commission costs No fixed obligation: If the companies use equity finance they have to pay dividend and if the companies use debt finance, they have to pay interest. What is the Cost of Retained Earnings? Jury Company wants to calculate the component costs in its capital structure. The firm could sell, at par, $100 preferred stock that pays a 12% annual dividend, but flotation costs of 5% would be incurred. The WACC is calculated using before-tax costs for all components. The three components of cost of capital are: 1. Jury Company bonds yield 9% in the market. The cost of retained earnings is: a. the cheapest component cost b. zero because the firm does not have to pay interest or dividend to itself c. always less than the cost of new common stock d. typically cheaper than the cost of preferred stock a 30. Since retained earnings are generated by the firm: a. there is no component cost for these funds. Hamilton Company's 8 percent coupon rate, quarterly payment, $1,000 par value bond, which matures … Cost of capital is the rate of return the firm expects to earn from its investment in order to increase the value of the firm in the market place. The corporate tax rate is 21%. 9.83% Component cost of debt Answer: b Diff: M 26 . Assume the firm has insufficient retained earnings to fund the equity portion of its capital budget. Normally, these funds are used for working capital and fixed asset purchases (capital expenditures) or allotted for paying off debt obligations. Flotation costs are the costs incurred by the company in issuing the new stock. The purpose of retaining these earnings can be varied and includes buying new equipment and machines, spending on research and development, or other activities that could potentially generate growth for the company. Flotation costs increase the cost of equity such that cost of new equity is higher than cost of (existing) equity. An organisation can reinvest its retained earnings or profits for the purpose expansion, modernisation, etc. 14. b. the funds have a positive cost that is more than new equity issues. a. What is its WACC? Thus, a firm’s cost of capital may be defined as “the rate of return the firm requires from investment in order to increase the value of the firm in the market place”. C) investors' unwillingness to purchase additional shares of common stock. Using the […] It is also referred to as weighted average cost of […] Retained earnings represent the portion of net profit on a company's income statement that is not paid out as dividends. B) the existence of flotation costs. Briefly explain why the cost of new equity is higher than the cost of retained earnings, calculate the cost of new equity, and calculate the retained earnings breakpoint--which is the point where new equity would have to be issued. b. These retained earnings are often reinvested in the company, such as through research and development, equipment replacement, or debt reduction. Retained earnings are the cumulative net earnings or profit of a firm after accounting for dividends. Some people refer to them as the earnings surplus. C)always less then the common new stock. Test December, questions and answers. 1 and 3 c. 2 and 3 d. 1, 2, and 3 c 6. If the dividend growth model is used, the cost of equity depends on 1. the firm's earnings growth rate 2. the current dividend payment 3. the price of the stock a. Preferred stock sells for $46, pays a dividend of $5.00, and carries a flotation cost of $1.10. Principles of Managerial Accounting (04 70 255) Academic year. Generally, the cost of retained earnings is slightly less than the cost of common stock since no issuance costs is incurred. The cost of retained earnings is the rate of return stockholders require on a firm's common stock. 1 and 2 b. Retained Earnings Equation Components Net Earnings: The resulting amount from subtracting all costs, expenses, taxes, interest charges, depreciation and amortization from the business revenues. The cost of retained earnings is the cost to a corporation of funds that it has generated internally. ADVERTISEMENTS: Cost of capital is a composite cost of the individual sources of funds including equity shares, preference shares, debt and retained earnings. It has 20-year, 12% semiannual coupon bonds that sell at their par value of $1,000. The firm will not be issuing any new stock. 2018/2019. D) the existence of financial leverage. Retained earnings represent a useful link between the income statement and the balance sheet, as they are recorded under shareholders’ equity, which connects the two statements. Common stock currently sells for $27, and is expected to pay a dividend of $.50. Take a hypothetical example whereby the earnings are generated by a public company that is all equity financed. It has 20-year, 12% semiannual coupon bonds that sell at their par value of $1,000. 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