Alice Stewart, who is the CFO of Meyers Foods, is teaching an upper-level course in corporate finance at the University of Limpopo.One of the assignments Alice gave her class was to compute the component costs of capital for Meyers Foods.Meyers Foods uses debt and ordianry shares (no preference shares) to finance its investments.Students in the class did not reach the same conclusions about the relationships among the components costs-that is, the after-tax cost of debt, rdT, the cost of retained earnings (i.e., internal equity), rs, and the cost of new, or external, equity, re.Which of the following relationships should be correct for Meyers Foods?

Question

Quizplus · Accepted Answer

The after-tax cost of debt (rdT) is typically lower than the cost of retained earnings (rs) because interest on debt is tax-deductible. The cost of new equity (re) is generally higher than the cost of retained earnings due to flotation costs and the higher risk perceived by investors. Therefore, the correct relationship is rdT < rs < re.

Alice Stewart, Who Is the CFO of Meyers Foods, Is