Which of the following statements is CORRECT? A) We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company's WACC for capital budgeting purposes. B) The cost of new equity (r_e) could possibly be lower than the cost of reinvested earnings (r_s) if the market risk premium, risk-free rate, and the company's beta all decline by a sufficiently large amount. C) A firm's cost of reinvesting earnings is the rate of return stockholders require on a firm's common stock. D) The component cost of preferred stock is expressed as r_p(1 - T), because preferred stock dividends are treated as fixed charges, similar to the treatment of interest on debt. E) In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income.

Question

Quizplus · Accepted Answer

Cost of reinvesting earnings is the rate of return required by the stockholders, not the cost of equity. The cost of equity is the return required by the equity investors, which may include both dividends and capital gains. The cost of equity may be estimated using the dividend growth model, capital asset pricing model or the bond yield plus risk premium approach.

Which of the Following Statements Is CORRECT