Wyden Brothers uses the CAPM to calculate the cost of equity capital. The company's capital structure consists of common stock, preferred stock, and debt. Which of the following events will reduce the company's WACC?
A) A reduction in the market risk premium.
B) An increase in the risk-free rate.
C) An increase in the company's beta.
D) An increase in expected inflation.
E) An increase in the flotation costs associated with issuing preferred stock.

Question

Quizplus · Accepted Answer

The WACC is calculated as a weighted average of the cost of equity, preferred stock, and debt, and is influenced by the risk-free rate, market risk premium, beta, and tax rate. A reduction in the market risk premium reduces the cost of equity, which in turn reduces the WACC. An increase in the risk-free rate, an increase in the company's beta, an increase in expected inflation, and an increase in flotation costs associated with issuing preferred stock all increase the cost of equity, preferred stock, or debt, which increases the WACC.

Wyden Brothers Uses the CAPM to Calculate the Cost of Equity