Flotation costs associated with issuing new equity cause the cost of external equity to be lower than the cost of retained earnings.

Question

Quizplus · Accepted Answer

Flotation costs associated with issuing new equity increase the cost of external equity because the company has to pay fees to investment bankers and other professionals to underwrite and market the new shares. The cost of retained earnings, on the other hand, is based on the opportunity cost of using internal funds instead of distributing them to shareholders as dividends, and it does not involve any direct expenses. Therefore, the cost of external equity is usually higher than the cost of retained earnings.

Flotation Costs Associated with Issuing New Equity Cause the Cost