A firm can raise up to $700 million for investment from a mixture of debt, preferred stock and retained equity. Above $700 million, the firm must issue new common stock. Assuming that debt costs and preferred stock costs remain unchanged, the marginal cost of capital for amounts up to $700 million will be ____ the marginal cost of capital for amounts over $700 million.

Question

Quizplus · Accepted Answer

The marginal cost of capital for amounts up to $700 million will be less than the marginal cost of capital for amounts over $700 million because the firm can raise up to $700 million through a mixture of debt, preferred stock, and retained equity, which generally have lower costs of capital compared to issuing new common stock. Once the firm exceeds $700 million, it must issue new common stock, which typically has a higher cost of capital. Therefore, the cost of capital will increase once the firm surpasses the $700 million threshold.

A Firm Can Raise Up to $700 Million for Investment