For a typical firm with a given capital structure, which of the following is correct? (Note: All rates are after taxes.)
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A. B. C. D. E.Explanation
k(d) = interest rate on the firm's new debt; k(e) = component cost of external equity, or equity obtained by issuing new common stock as opposed to retaining earnings; k(s) = component cost of retainedearnings (or internal equity). Typically, the cost of equity is higher than the cost of retained earnings because of flotation costs involved in issuing new common stock. The cost of debt is the lowest because it is the relevant cost of new debt, taking into account the tax deductibility of interest, and because of this deductibility of interest, it is the lowest component. The WACC is a weighted average of all the components, so it would be somewhere in the middle.