CFA® Level 1: CFA® Level 1 Exam Preparation

Which statement is most correct?

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Question

Which of the following statements is most correct?

Answers

A. We ideally would like to use historical measures of the component costs from prior financing in estimating the appropriate weighted average cost of capital.

B. The cost of a new equity issuance could possibly be lower than the cost of retained earnings if the market risk premium and risk-free rate decline by a substantial amount.

C. None of these statements.

D. In the weighted average cost of capital calculation, we must adjust the cost of preferred stock for the tax exclusion of 70% of dividend income.

E. All of these statements.

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Explanations

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A. B. C. D. E.

Unlike interest expense on debt, preferred dividends are not deductible, hence there are no tax savings associated with the use of preferred stock. The component costs of WACC should reflect the costs of new financing not historical measures. The cost of issuing new equity is always greater than the cost of retained earnings because of the existence of flotation costs.

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